Business Economics

Question 1

Specialisation

Answer 1

the division of labour where production is split into different tasks and specific people are allocated to each task

Question 2

Specialisation - advantages

Answer 2

• people can specialise in thing they’re best at -> increased labour productivity
• firms can achieve economies of scale
• more efficient production
• training costs reduced if workers only trained to perform certain limited tasks

Question 3

Specialisation - disadvantages

Answer 3

• repetitive tasks -> workers’ boredom
• countries less self-sufficient -> large problem if trade is disrupted
• can lead to lack of flexibility

Question 4

Why trade is important with specialisation

Answer 4

• Economies have to be able to obtain the things they’re no longer making for themselves
• Types of trading - barter system: swapping goods with other countries is one way a country can get what it needs - very inefficient as takes time and effort to find traders
  - Using money. Money has four functions: a medium of exchange, a measure of value, a store of value, a standard/method of deferred payment

Question 5

Marginal cost

Answer 5

• the extra cost incurred as a result of producing the final unit of output
• MC Curve - when MC

Question 6

Law of diminishing returns

Answer 6

• if one variable factor of production is increased while other factors stay fixed, eventually the marginal returns from the variable factor will begin to decrease
• only applies in short run
• as MP rises, MC falls
• as MP falls, MC rises

Question 7

Marginal Product

Answer 7

The additional output produced by adding one more unit of a factor input

Question 8

Economies of scale

Answer 8

• the cost advantages of production on a large scale
• can be internal - technical, purchasing, managerial, financial, risk-bearing, marketing
• can be external - involve changes outside firm e.g. lots of firms may share resources if near each other

Question 9

Technical EOS

Answer 9

• production line methods can be used by large firms to make low AC
• large firms can purchase specialised equipment to reduce AC
• workers can specialise -> increased efficiency
• law of increased dimensions-> more storage space

Question 10

Purchasing EOS

Answer 10

• larger firms will need larger quantities and as they’re most important customers, they’ll be able to drive a hard bargain

Question 11

Managerial EOS

Answer 11

• large firms can employ specialist managers -> better decision making
• no. of managers doesn’t depend on production scale -> reduces management cost per unit

Question 12

Financial EOS

Answer 12

• large firms can borrow money at lower interest rate

Question 13

Risk-bearing EOS

Answer 13

• larger firms can diversify into different product areas and different markets -> leads to more predictable demand
• larger firms can take more risks; can absorb cost of failure more easily

Question 14

Marketing EOS

Answer 14

• larger firms’ advertising have lower cost per unit
• cost per product of advertising several products is lower
• larger firms can benefit from brand awareness - trust from consumers

Question 15

Diseconomies of scale

Answer 15

• cause AC to rise as output rises
• internal - wastage or loss can increase as materials might seem in plentiful supply
  - communications may become more difficult as firm grows
  - manager may have less control
  - more difficult to coordinate activities between different departments
• external - price of raw materials may increase (greater demand)
  - local supplies may not be sufficient - may have to buy goods from further away -> expensive

Question 16

Long run average cost

Answer 16

• in LR firm can change all factors of production. When it does, moves onto new SRAC curve
• min possible AC at each level of output shown by LRAC curve
• AC falls as output increases -> firm experiencing internal economies of scale
• AC rises as output increases when firm is experiencing internal diseconomies of scale
• external EOS cause LRAC shift downwards by reducing AC at all output levels
• External diseconomies of scale will force shift upwards

Question 17

L shaped LRAC curve

Answer 17

• some economists claim AC falls sharply as output increases and then either continue to fall slowly or level off
• .> while some internal DEOS will occur with increasing output they’ll be offset by continued reductions in AC - so LRAC won’t curve upwards

Question 18

Increasing returns to scale

Answer 18

• when an increase in all factor inputs leads to a more than proportional increase in output
• LRAC will fall

Question 19

Constant returns to scale

Answer 19

• when an increase in all factor inputs leads to a proportional increase in output
• LRAC will stay the same

Question 20

Decreasing returns to scale

Answer 20

• when an increase in all factor inputs leads to a less than proportional increase in output
• LRAC will increase

Question 21

Price takes firms

Answer 21

• have no power to control price it sells (controlled by market)
• demand is perfectly elastic (AC=MR)

Question 22

Price maker firms

Answer 22

• total revenue max. when PED=-1 - midpoint of AR curve
• demand curve = AR curve
• when total revenue is at max. , MR=0

Question 23

Profit

Answer 23

• if TR>TVC, then firm will continue to produce. If firm stops production, will be worse
• if TR>TVC, then firm will close immediately. If it continues to produce, it will be worse off
• profit max. when MC=MR

Question 24

Objective of firms

Answer 24

maximising profit - traditional objective. Max profit in LR means sacrificing profits in SR.

• maximising sales - May try this in SR to gain monopoly power to make supernormal profits in LR. High sales make borrowing money easier. Maximised when AR=AC - highest level of output firm can sustain in long run. If sales increased further, firm would be making a loss
• maximising revenue - may try to max. revenue in SR to gain monopoly power to make supernormal profits in LR. Maximised when MR=0

Question 25

Cooperate Social Responsibility (CSR)

Answer 25

• involves firms operating in way that brings benefits to society, as well as trying to make supernormal profits
• e.g. Firm may try to protect environment using sustainable resources. Firms may support local businesses by using supplies in their region. Firms may choose to pay workers above standard market rate
• a firms CSR policies can help increase profits by encouraging consumers to buy from them

Question 26

Divorce of ownership from control

Answer 26

• owners of firm are no longer in day to day control. As firms grow, owners often raise finance by selling shares, Despite new part owners, firm actually run by directors, who are appointed to control businesses in shareholders interest
• can lead to principal agent problem

Question 27

Principal Agent problem

Answer 27

• where a principal (e.g. shareholders) pays for an agent to act in their interests, but instead the agent acts in their own self-interest
• directors may be keen to grow some aspects of the firm as they enjoy running large organisation or will further their career
• employees likely aim to increase own pay or benefits

Question 28

How owners can retain control after principal agent problem

Answer 28

• through accountability - managers and directors have to justify what they’ve done in past and explain future plans and intentions
• owners may also offer incentives directors which make an attractive objective for directors to pursue
• shareholders can remove directors by vote but often lack info to do this