AL Unit 7: The Price System and the Microeconomy

Question 1

Utility

Answer 1

A measure of the level of happiness or satisfaction someone gets from the consumption of a good. Assumes satisfaction can be measured in units. The principle or law of diminishing marginal utility is where marginal utility is the additional utility derived from the consumption of one more unit. Suggests that are consumption increases marginal utility will decrease. Can also be used for prices on sale. Likely to be bought

Question 2

Total utility

Answer 2

Overall satisfaction derived from consumption of all units over time

Question 3

Marginal utility

Answer 3

Additional utility derived from consumption of one more unit

Question 4

Equi-marginal principle

Answer 4

A consumer is in equilibrium when its not possible to switch expenditure to increase total utility. When it applies it is not possible to increase total utility by relocating spending between any available products. Income has maximised utility
MUa/Pa = MUb/Pb = MUc/Pc

Question 5

Assumptions of equi-marginal principle

Answer 5

Consumers have limited income
Consumers will always behave rationally
Consumers seek to maximise utility

Question 6

Derivation of individual demand

Answer 6

If the price of a good is reduced, the price of another good and income is unchanged. MU/P can be recalculated. Gives new consumer equilibrium. Total utility has increased

Question 7

Limitations of marginal utility theory and assumptions of rationality

Answer 7

MUT assumes consumers can put their wants in order and assign value to satisfaction. DMU assumes consumers act and behave rationally when purchasing. Empirical/real world evidence shows purchasing isn’t only influenced by utility

Question 8

Indifference curves

Answer 8

It does not always follow that consumers will buy more of a good when price falls, they will only buy a particular good if it is something they actually prefer. Preferences are represented by indifferences curves. SHows all of the combinations of 2 goods for equal satisfaction. Slopes down to indicate that a fall in consumption of one good is accompanied by an increase in consumption of the other for equal utility. A map shows a number of indifference curves. Higher curves represent higher utility. Rational consumers will opt for the highest curve. Curves can’t cross.

Question 9

Marginal rate of substitution

Answer 9

The slope represents the extent to which the consumer is willing to substitute good. The rate at which this happens is the marginal rate of substitution

Question 10

Budget lines

Answer 10

Consumers are restricted due to limited disposable income and prices. A budget line shows the combinations of 2 gods a consumer can purchase with a given income and prices

Question 11

Causes of a shift in budget lines

Answer 11

A change in the price of one good causes the budget line to pivot. This is the substitution effect of a price change. Rational consumers will always substitute towards the good that is relatively cheaper. Real income has also increased which is the income effect of a price change

Question 12

Effect of income changes on consumption

Answer 12

Consumer choice is optimal where the budget line touches the highest indifference curve. If incomes rise a better combination of goods is chosen. More will be consumed so if the budget constraint rises, both will be consumed more and there is a new optimal position. This position change is when both goods are normal

Question 13

The substitution and income effect of a price change

Answer 13

If the price of a good rises consumers have less spending power, represented by a new budget line. This pivots down towards the origin because less is consumed with the same level of income. Income effect can be eliminated by removing the reduction in real income with an imaginary budget line parallel to the new one but tangent to the original indifference curve. For inferior goods as real incomes rise, consumers substitute more expensive and better quality goods so the income effect is negative but doesn’t outweigh the substitution effect

Question 14

Income and substitution effect of price changes on a graph

Answer 14

The change has 2 stages:
- movement along the curve. This is the substitution effect since the consumer buys less
- shift down. This is the income effect because the consumer has less spending power

Question 15

Giffen goods

Answer 15

Demand falls and price falls. Could be a staple food where consumption rises with price since real incomes fell. Demand curve is upward sloping as the income effect is negative and greater than the substitution effect

Question 16

Limitations of indifference curves

Answer 16

Consumers have more than 2 choices
Indifference implies consumes will accept any combination of the 2 goods. May express wants and needs in rank order instead
Assumes consumer rationality

Question 17

Efficiency

Answer 17

Economic efficiency exists when it can be judged that all scarce resources are being used in the best way. The greatest level of wants is being met and consists of productive and allocative efficiency. When both types exist there is efficient resource allocation. Globally it is achieved when all economies do this but protectionist policies make this impossible

Question 18

Productive efficiency

Answer 18

Occurs when firms produce at the lowest cost and make the best use of resources

Question 19

Allocative efficiency

Answer 19

When firms produce the combination of goods and services wanted by consumers. Gives maximum utility at current income. There is no waste. Price they are willing to pay reflects preferences and benefits derived from consumption. The marginal cost is a measure of the opportunity cost of resources to produce the last unit. Where price is MC, consumers will pay MC signalling allocative efficiency

Question 20

Conditions for productive efficiency

Answer 20

Can be demonstrated through average cost curve. A point on a PPC shows maximum production for any combination of 2 products. Productive efficiency can only exist when producing on the PPC. Competition can lead to productive efficiency. Firms are constrained to produce at the lowest possible cost since they have a profit incentive. A failure to d this in a competitive market could lead to bankruptcy. Lowest point on AC curve is productive efficiency

Question 21

Conditions for allocative efficiency

Answer 21

Exists when P=MC. Price paid by consumer represents the economic cost of the last unit. Any PPC point could be allocatively efficient while the exact location depends on consumer preference. Competition can lead to this since firms are constrained to produce products consumers most desire relative to costs. Desire to make greatest possible profit. In competitive markets firms are forced to produce those most demanded. Point of equilibrium is where P=MC

Question 22

Pareto optimality

Answer 22

Occurs when it is impossible to make 1 person better off without making someone else worse off. Represents the best possible situation with most efficiency allocation. When operating on a PPC it is in a state of pareto optimality. Any point within the PPC is pareto inefficient. If allocation is not pareto efficient there can be improvement. If there are welfare losses on the PPC, reallocation leads to pareto improvement but may require compensation

Question 23

Dynamic efficiency

Answer 23

Benefits a firm over time. Resources are allocated in such a way that output rises relative to resource increase. Achieved when a firm meets the changing market needs by introducing new production processes in response to competition. By using excess profits firms can engage in R&D to protect market share. Lower prices for consumers. Requires investment which can initially cause higher costs. If a firm doesn’t invest, it may be less efficiency so forced to leave market. LRAC shift down when dynamically inefficient

Question 24

Consequences of market failure

Answer 24

Where there are externalities in the market
The provision of merit and demerit goods
The provision of public and quasi-public goods
Information fialure
Adverse selection or moral hazard
Abuse of monopoly power

Question 25

Externalities

Answer 25

A problem arises if someone not involved in an economic decision is affected by that decision. Those not directly involved are third parties. A negative externality occurs when the side effects have a negative or damaging impact on third parties involving unexpected cost to them. A positive externality is where the side effects provide unexpected benefits to third parties

Question 26

Private costs and benefits

Answer 26

Experienced by those directly involved in the decision. PC are incurred by firms, individuals or others who carry out the action as producers or consumers. PB are directly received by those who produce or consume the good or service

Question 27

External costs and benefits

Answer 27

A consequence of externalities from an action. Not paid for nor do the advantages accrue those responsible. They fall on the third parties

Question 28

Social costs and benefits

Answer 28

The total costs and benefit incurred or accruing to the society as a result of an action. There is a problem where PC does not equal SC or PB does not equal SB. The external costs or benefits distort the efficient allocation of resources. It is possible for PC=SC. All costs accrue to the individual or firm. There are no externalities. It is also possible for there is be a difference. If SB>PB there is a positive externality that produces an external benefit

Question 29

Negative production externalities

Answer 29

Effects that occur as a result of production. There is no cost to the firm. Occur when third parties are harmed by the production of a good or service. There is a misallocation of resources. Marginal external costs increase as output increases. MPC is supply. No consumption externalities so demand slopes down. MSB=MPB=D. Socially optimum output is where MSB=MSC. There is deadweight welfare loss due to the overproduction

Question 30

Positive production externalities

Answer 30

Benefits to third parties by producers of goods and services. MSC<MPC. Assuming no consumption externalities MSB=MPB. Socially efficient level output is where MSB=MSC. This is above output in a competitive market. External benefits cause output below socially efficient level. Deadweight welfare loss results from the underproduction

Question 31

Negative consumption externalities

Answer 31

Created by consumers due to use of product that causes harm to third parties not involved in consumption. MSB<MPB. Assuming no production externalities the socially efficient level of output is where MSB=MSC. Deadweight welfare loss caused by overconsumption

Question 32

Positive consumption externalities

Answer 32

Spillover effects of consumption of a good or service on others. Argument for government provision of merit goods. MSB>MPB the gap between is MEB. Assuming no external benefits, level of output is below social optimum. Underconsumption

Question 33

Asymmetric information and moral hazard

Answer 33

The quality of information available to consumers varies and can lead to a misallocation of resources. A lack of information tends to lead to an overestimation of consumption benefits. Sellers generally know more than buyers. Asymmetric information occurs when 1 party has information the other party doesn’t but buyers ted to have more information in terms of insurance claims and bank loans

Question 34

Adverse selection and moral hazard

Answer 34

Hidden characteristics when only 1 party knows more about a situation than the other. The outcome is adverse selection. Hidden actions when 1 party takes actions the other can’t observe by affects both. These are a moral hazard

Question 35

Use of costs and benefits

Answer 35

Where the full range of costs and benefits is considered this is cost-benefit analysis. Takes a long a wide view of projects. Long view comes from the nature of most public sector investment. Wide view comes form need to take into account full SC and SB. Major projects can produce large and controversial side effects especially where externalities fall on people and communities that don’t have direct connections. Attempts to quantify the opportunity cost to society of various outcomes. Differs from private sector methods of appraisal. Seeks to include all costs and benefits. Often has to provide a shadow price for costs and benefits where no market price is available

Question 36

Development of a cost-benefit analysis

Answer 36

Identify all relevant costs and benefits
Monetary value on costs and benefits
Applies for long term implications
Earlier stages are drawn together so the outcome is present to aid decision making

Question 37

Production

Answer 37

Normally producers are firms whose demand for factors are derived form the needs of operating. The task is to combine factors in ways to be efficient, competitive and profitable. The most important decision is the mix of labour and capital at least cost or most efficient for a quantity of output. Therefore firms have to choose between alternative production methods. Joining points of equal output on different production curves gives and isoquant

Question 38

Short run production function

Answer 38

Labour is the usual variable factor in the short run where all others are fixed. If there is no labour there is no output or no total product. The production function graph shows the relationship between the quantity of factor inputs and total output. The marginal product is the increase in total product that occurs from an additional unit of input. As the numbers of workers increases, marginal product declines which is the law of diminishing returns. Adding more workers can be a short term way of increasing output by marginal product falls and may become negative. Average product is calculated by dividing total product by number of workers. Simple measure of labour productivity

Question 39

Short run cost function

Answer 39

A firm has objectives like profit maximisation, avoidance of risk taking and long term growth. All firms are headed by an entrepreneur. A firm and its entrepreneur must consider all factor costs in output. These are private costs directly incurred by owners. External costs may be created but not taken into account by the firm. The firm is the organisation that transfers factor inputs to produce goods and services for the market

Question 40

Fixed and variable costs

Answer 40

Fixed costs are independent of output. Total fixed costs are a horizontal line. At 0 output any costs may be fixed. Some firms where capacity is fixed or where the product is perishable operate where fixed costs are a large proportion of total costs. Advised to produce a large output to reduce unit costs or sell available capacity to make the firm more likely to cover total costs. Variable costs are directly related to output and are incurred directly in the production process

Question 41

Total, average and marginal costs

Answer 41

For most firms, increasing output will raise TC. MC will be positive as extra input is used. Firms only want to increase output when expected sales revenue > extra costs. As more variable factors are added to fixed, contribution of each extra worker will fall. Diminishing marginal returns causes MC and AVC to rise

Question 42

Shape of short rune AC and MC curves

Answer 42

Short run ATC is the result of the interaction between AFC and AVC. As output rises, AFC falls because TEC is spread over more output. AVC will be rising because of diminishing returns to variable factor. Eventually this outweighs the effect of falling AFC causing ATC to rise. This is the U shape because of the law of diminishing returns. MC crosses AVC and ATC at lowest points so the most efficiency output is where ATC or UC is lowest. This is optimum output where the firm is productively efficient in the short run. Not necessarily most profitable since profit maximisation may only be possible in long run. Profit depends on relationship between revenue and costs

Question 43

Long run production function

Answer 43

The factor that takes the longest to change is capital. All factors are variable in the long run. Gives the firm greater scope to vary mix of inputs to produce most efficiently. Firms must know factor costs and consider in relation to the additional product form using 1 more unit of a factor. Can derive the long run production function for a firm by constructing an isoquant map using the principles of a production function

Question 44

Long run production function formula

Answer 44

Marginal product factor A/price of factor A = Marginal product factor B/price of factor B…
All factors must be variable for this
Firms should aim to be in this position

Question 45

Returns to scale

Answer 45

When less capital and labour is needed per unit of output is increasing returns to scale. As production expands further, more labour and capital are needed. Increasing width of gap between isoquants shows decreasing returns to scale. In the long run, labour and capital can be varied and actual mix depends on prices. Lines of constant relative costs of factors are isocosts. The most economically efficient process is obtained by bringing together isoquants and isocosts so linking physical and economic sides of production. The point where the isocost is tangential to an isoquant is the best combination. The long run production function can be shown by joining all various tangential points and is useful for longer planning

Question 46

Returns to scale in practive

Answer 46

Hard for firms to determine isoquants
Assumed that in the long run it is possible to switch factors
Some employers reluctant to switch labour and capital

Question 47

Long run cost function

Answer 47

In the long run firms can alter all inputs, it is operating on a larger scale. In the very long run, technological change can change all of production. With rapid development the time between short and long run is reduced. Shifts product curves upward and cost curves down since firms are more efficient. A firm can lower cost structure over time by increasing capital relative to labour and increase productivity

Question 48

Shape of long run average cost curve

Answer 48

LRAC shows least cost combination of producing an output flatter compared to SRAC showing falling long run costs over time. Allows firms to lower prices without affecting profits. As output increases so does operation scale. Envelopes a series of SRAS curves. These just touch or are tangential to the LRAC as output rises. It is the lowest average cost for each output level where all factors are variable. Does not mean the firm is producing at the minimum on each SRAC curve

Question 49

Minimum efficient scale

Answer 49

A firm producing at optimum output in short run and lowest average cost in long run has maximised efficiency. This is minimum efficient scale since it is te lowest output level where average costs are minimised. Where minimum efficient scale is low there are a lot of firms. When high, competition is between a few large firms

Question 50

Internal and external diseconomies of scale

Answer 50

Economies of scale is shown by the downward sloping part of the LRAC. If a firm gets increasing returns from its factors, it can produce more with less factors so is producing at a lower average cost. The LRAC slopes up after the minimum because cost per unit output may rise with scale of output which is diseconomies of scale

Question 51

Economies of scale and decreasing average costs

Answer 51

Economies of scale can only occur in the long run. Internal occur because output is rising faster than inputs. If proportional, there are constant returns to scale and LRAC is horizontal. If output is less than proportional there are diminishing returns to scale

Question 52

Technical economies of scale

Answer 52

Advantages through more efficient production. Some techniques are only viable for certain output levels

Question 53

Purchasing economies of scale

Answer 53

Can increase purchasing power with suppliers through bulk buying. Also where number of items sold falls to concentrate on other items

Question 54

Marketing economies of scale

Answer 54

Large firms can promote and pay lower advertising rates. Includes saving on logistics costs

Question 55

Managerial economies of scale

Answer 55

A result of specialisation so experts can be hired

Question 56

Financial economies of scale

Answer 56

Large firms have better and cheaper access to borrowing due to lower risk

Question 57

External economies of scale

Answer 57

Received as a consequence of the growth of an industry. May be a reason for the trend towards rival firms being in the same location. Advantages include availability of skilled labour and convenient supply

Question 58

Diseconomies of scale

Answer 58

Most likely source is management and coordination with poor communications. After growth a firm may decide to split into 2 firms. Lack of motivation due to being an insignificant part for workers. The concentration of firms in 1 location leads to traffic congestion, land shortages and shortages of skilled labour

Question 59

Total, average and marginal revenue

Answer 59

In a fully competitive market the firm is a price taker. Demand is horizontal and revenue depends on number of goods sold. Market demand slopes down. In any other market the firms is a price maker and demand slopes down. As output changes so does price and revenue but the extent depends on PED. DC=ARC. MR is always <AR since firm can only sell more by reducing price

Question 60

Normal, subnormal and supernormal profit

Answer 60

Profit is left over after total costs are taken from TR. Includes money paid to factors and loans. Opportunity cost also needs to be taken into account. A firm will expect a minimum profit what what could be earned elsewhere. It is the minimum a firm must receive to remain in business
P=TR-TC. Any profit above normal is supernormal and signals for firms firms to enter the market
SP=TP-NP. Subnormal is less than normal. Firm may leave in the long run

Question 61

Perfect and imperfect competition

Answer 61

Perfect competition
Monopolistic competition
Oligopoly
Monopoly
Natural monopoly

Question 62

Assumptions of perfect competition

Answer 62

Many buyers and sellers
The buyers and sellers are price takes and have the accept the price that prevails and are unable to influence it in any way
Perfect knowledge among producers and consumers
Product is homogenous
No barriers to entry or exit
Perfect factor mobility in the long run
No transport costs
All producers have access to the same technology
Each firms has perfectly elastic demand
Firms aim to maximise profits
Only normal profit can be earned in the long run

Question 63

Perfect competition

Answer 63

In the short run a firm could make supernormal, normal or subnormal profit. If unable to cover short run variable costs it should exit the market. In the long run if a firm makes supernormal profits, new firms will be attracted but if a firm makes subnormal profits it will leave the industry. Perfect competition has been criticised for being unrelaistic but it is still effective

Question 64

Imperfect competition

Answer 64

Monopolistic competition
Oligopoly
Monopoly
Natural monopoly

Question 65

Assumptions of monopolistic competition

Answer 65

There are a lot of firms
Products are differentiated
Each firms demand curve slopes down from left to right
Demand is relatively price elastic but not perfectly
Great use made of advertising to build brand loyalty
No barriers to entry and exit
Firms aim to maximise profits
Only normal profit can be made in the long run

Question 66

Monopolistic competition

Answer 66

In the short run a firm could make supernormal, normal and subnormal profit. Since there are no barriers to entry or exit firms can leave or enter the market in response to these profits. Generally a more realistic model of the behaviour of firms because there is often a lot of competition between firms that sell similar products

Question 67

Assumptions of oligopoly

Answer 67

Small number of firms
Differentiated products
Great use made of advertising to build up brand loyalty
Barriers to entry and exit
Firms can make supernormal profit in the long and short run
Mixture of price makers and takers
Firms and interdependent
A degree of collusion between firms operating in a cartel
Kinked demand curve
Great deal of price stability

Question 68

Oligopoly

Answer 68

The kinked demand curve results form the fact that these firms try to anticipate the reactions of rival firms to their actions. Above the kink it is assumed that if an oligopolistic firm increases price other firms will not follow so demand is elastic. Below the kink it is also assumed that if an oligopolistic firm reduces price, other firms will follow so demand is inelastic. Oligopoly is a reasonably realistic model but is more complex than other models because there are many ways in which firms may interact

Question 69

Assumptions of monopoly

Answer 69

There is one firm
Can be defined in terms of market share
Price maker
No substitutes
High barriers to entry
Supernormal profit exit in the short and long run because of the barriers to entry
Demand for the firms product is also the market demand so slopes down left to right
Marginal revenue is always less than average revenue
Firms aims to maximise profits

Question 70

Monopoly

Answer 70

Has disadvantages for the consumer but this does not always need to be the case

Question 71

Natural monopoly

Answer 71

Exists where a single supplier has a very significant cost advantage as a result of being in a monopoly situation. If there were competition, costs of production would increase. This is a natural monopoly because it avoids the extra costs that would come about as the result of a duplication of resources. One firm may have sufficient economies of scale to satisfy market demand more efficiently than 2 or more firms

Question 72

Barriers to entry and exit

Answer 72

Legal barriers: a potent can act as a barrier to entry because other firms will not have permission to produce and sell a product
Market barriers: a lot of money is spent on building a strong brand image and this cost can be a barrier to entry
Cost barriers: economies of scale occur when increased output leads to lower average costs so new firms with low output will experience relatively high costs
Physical barriers: some countries have supplies of a product and the absence of this may act as a barrier to entry

Question 73

Revenue in different market structures

Answer 73

AR and MR curves are horizontal in perfect competition. AR curve is also demand curve since AR is the amount of revenue per unit sold and this equals the price but are downward sloping in monopolistic competition, oligopoly, monopoly and natural monopoly with the MR curve below the AR curve. The AR curve in oligopoly is kinked and MR curve discontinues.

Question 74

Output in different market structures

Answer 74

Profit maximising output in all structures is when MC = MR

Question 75

Profit in different market structures

Answer 75

It is possible for firms in all structures to make supernormal profit in the short run but in perfect and monopolistic competition these will be competed away in the long run and only normal profit is made

Question 76

Shutdown price in different market structures

Answer 76

A firm can make subnormal profit in the short run and continue as long as average variable costs are being covered otherwise it will be forced to shut down. In the long run a firm will need to at least make normal profit and P will need to equal AC

Question 77

Supply in different market structures

Answer 77

In the short run a firms supply curve in perfect competition its MC curve above the point where it intersects the AVC curve. In the long run it is its MC curve above the point where it intersects the ATC curve

Question 78

Efficiency in different market structures

Answer 78

Firms in perfect competition are productively and allocatively efficient in the long run. In other structures there is X inefficiency where production is not at the maximising AC and P does not equal MC

Question 79

Contestable markets

Answer 79

It is relatively easy for a new firm to enter a market so existing firms are continually influenced by the threat of possible entry of new firms making them behave as if the potential firms were actually already operating

Question 80

Assumptions of contestable markets

Answer 80

No barriers to entry and exit
Firms already in the market continually face competition
Pressure on firms to be efficient
Supernormal profits make in short run, only normal profits in the long run
A perfectly contestable market will have no sunk costs
Perfect information
All firms have access to the same level of technology

Question 81

Implications of contestable markets

Answer 81

Existence of low barriers to entry and exit means new firms can enter the market to provide competition
This threat means existing firms will be productively, allocatively and dynamically efficient
Absence of sunk costs reduces risk of entry
Existing firms focus more on sales than profit maximisation
Size and number of firms is irrelevant

Question 82

Price competition

Answer 82

Refers to a situation in which firms try to sell their products at lower prices than similar products sold by other firms. Firms develop different price strategies to beat their competitors usually setting the same or lower prices

Question 83

Non price competition

Answer 83

In most markets firms compete in terms of price but in monopolistic and oligopoly competitions there is non price competition rather than using changes in price to compete

Question 84

What does non price competition involve?

Answer 84

Advertising and product promotion
Branding and creation and management of brand image and customer loyalty
Sales promotions
Distribution
Distinctive or exclusive packaging
Differences in quality or design
Establishment of a unique selling point through product differentiation
Warranties and after sales services
Provision of a loyalty card card which gives rewards
Establishment of ethical or environmental reputation

Question 85

Collusion

Answer 85

In oligopoly there may be collusion between firms which cooperate for their mutual benefit. Firms are interdependent so consider the likely reactions of the other firms. Collusion is a way of lowering some costs to maintain supernormal profit reducing consumer welfare. A price agreement is where firms agree to fix prices between themselves. A cartel is where a number of firms agree to work together such as by limiting output to keep prices higher than if there was competition

Question 86

The prisoners dilema

Answer 86

Firms in an oligopolistic market make decisions in uncertainty about how rivals will react. Game theory analyses the behaviour of firms in this situation. The prisoners dilema is part of game theory where 2 prisoners are questioned about their guilt. They must decide to confess or not without knowing what the other will do when a confession carries a lighter punishment. Shows why 2 individuals might not cooperate even if it is in their best interest

Question 87

Two player pay off matrix

Answer 87

Self interest might make it hard for an oligopoly firm to maintain cooperation. This is a visual representation of all the possible outcomes that can occur when 2 firms have to make a strategic decision

Question 88

Concentration ratio

Answer 88

Shows the percentage of a particular market that is accounted for by a certain number of firms. Concentration ratio of the largest firms in an oligopoly is very high

Question 89

Reasons for small firms surviving

Answer 89

Size of market is small
Firm may be in a very specific niche market
Firm is provding customers with personal services
Firm may have just started
Owners of the firm prefer it to remain small
Small firms may receive financial support from the government
Small firms may be more responsive to demand
Small firms may be more innovative
The small firm may not be able to grow because of finances
In some industries there have been an increase in outsourcing and contracting out
A small firm may be more efficient

Question 90

Reasons for growth of firms

Answer 90

Decrease costs to take advantage of economies of scale
To reduce risk to be stronger and safer from takeover or mergers
To increase profits
To fulfill management objectives
To dominate a market

Question 91

Firm vs industry

Answer 91

A firm is a distinct organisation that is owned separately from any other organisation. An entrepreneur will bring together factors of production to produce. An industry involves a number of firms which produce similar products. Firms can grow through internal and external growth

Question 92

Internal growth of firms

Answer 92

Due to firms increasing in size through producing and selling more measured by volume of sales, sales revenue, number of employees, market share and size of profit

Question 93

External growth of firms

Answer 93

Comes about as a result of a merger or takeover where 2 or more firms combine through integration

Question 94

Horizontal integration

Answer 94

Where 2 or more firms at the same stage of production join together

Question 95

Vertical integration

Answer 95

Where 2 or more firms at different stages of production merge. It it involves going to an earlier stage it is backward vertical integration. If it involves going to a alter stage in production it is forward vertical integration

Question 96

Conglomerate integration

Answer 96

Where 2 or more firms merge even though they are operating in different markets that do not always have any relationship. It can spread risks in different markets through diversification

Question 97

Reasons for integration

Answer 97

Horizontal: can benefit from economies of scale
Backward vertical: might want a firm earlier in the supply chain
Forward vertical: might want a firm further up the supply chain
Conglomerate: spread risk through diversification

Question 98

Consequences of integration

Answer 98

Economies of scale
Rationalisation which is eliminating parts of the operation that are inefficient and unprofitable
Sharing of knowledge which could reduce or remove asymmetric information
Strengthen anti takeover defence ad protective strategies
Research and development funds can increase which increases long run profit and competitiveness

Question 99

Cartel

Answer 99

A cartel is a grouping of producers that work together to defend shared interests. They are created when a few large producers decide to collude. They can restrict output and price

Question 100

Conditions for an effective cartel

Answer 100

Barriers to entry: more likely to be effective with high barriers
Control over price and output
Setting rules: will need to set rules for the members so that risks that would exist without a cartel are reduced
Policing rules: effective where all members can be policed to ensure rules obeyed
Leading firm: effective where there is a leading firm similar product and similar cost structure

Question 101

Positive effects of a cartel for producers

Answer 101

Protection of shared interest
Avoidance of price competition
Revenue may increase
Members will have a dominant market position

Question 102

Negative effects of a cartel for consumers

Answer 102

Higher prices because PED is reduced
Lack of transparency from producers
Restricted output
Carving a market to split into territories that do not compete reducing choice

Question 103

Principal agent problem

Answer 103

The principal is the owner and will hire an agent to run the firm on a daily basis. The agent may not run the firm the way the owner would like. They may have different objectives

Question 104

Profit maximising objective

Answer 104

Traditionally regarded as the main objective. It occurs at the level of output where the marginal cost of production is equal to the marginal revenue obtained by a firm

Question 105

Profit satisficing

Answer 105

Managers may want to deal in a manner with all stakeholders so that they are satisfied

Question 106

Revenue maximising

Answer 106

This is the objective where salaries are linked to revenue rather than profit. Revenue is maximised where MR = 0

Question 107

Sales maximising

Answer 107

Managers aim to maximise volume of sales rather than the revenue from them

Question 108

Growth maximisation

Answer 108

Where managers aim to increase the size of the firm because it will be less vulnerable to merge or takeover and raised salaries

Question 109

Survival

Answer 109

In the first years the objective may be to survive especially where firms tend not to survive for long

Question 110

Strategic objective

Answer 110

May establish objectives in a broad approach and aim to operate without ethical or environmental problems

Question 111

Price discrimination

Answer 111

Involves charging a different price to different groups of people for the same good mainly by monopolies

Question 112

Conditions for effective price discrimination

Answer 112

Different elasticities of demand
Different prices should not be a reflection of differences in costs
Market segmentation like geographical regions, times of day or groups of people
No resale
Monopoly power

Question 113

Degrees of price discrimination

Answer 113

1st: Involves considering individual customers. The firm needs to be able to find out what each customer is willing to pay and then sell it at that price. Each unit is so sold at a different price
2nd: Involves allowing customers to choose a deal. The firm offers a special deal to customers who meet certain conditions
3rd: Involves offering special discounts to members of certain groups

Question 114

Consequences of price discrimination for producer

Answer 114

Increase in revenue and profit
Cross subsidisation using supernormal profit
Economies of scale
Capacity utilisation

Question 115

Consequences of price discrimination for consumer

Answer 115

Consumer payments are specialised
Consumer surplus is reduced but not if they can buy at a lower price
Might make a market more contestable allowing cheap prices

Question 116

Other pricing policies

Answer 116

Limit pricing below profit maximising to discourage new firms entering
Predatory pricing where a firm charges a price lower than competitors to force others out of the industry
Price leadership where there is collusion so firms will follow the prices of one firm. Aim is to maximise profits of all firms by behaving as if they were a monopoly

Question 117

Normal downward sloping demand curve

Answer 117

Shows relationship between PED and total revenue, AR and MR. If perfectly elastic, MR = P. If downward sloping, MR < P because price has to be reduced for all products to sell just 1 more. AR = D. TR is rising when demand is elastic at maximum when unit elastic and falling when inelastic

Question 118

Kinked demand curve

Answer 118

Oligopolistic markets try to anticipate the reactions of rival firms to actions. Kinked demand curve is when there is no collusion and shows mutual interdependence of oligopoly. If an oligopolistic firm increases price, other firms will not follow so demand above the kink is price elastic. A fall in price will lead to a rise in TR. If an oligopolistic firm reduces prices, other firms will follow so demand below the kink is price inelastic. A rise in price will lead to a rise in TR