Chapter 2 - The Firm and Its Costs

Question 1

Process of Competition Bureau

Answer 1

1. Undertake an analysis
2. Carry out investigation
3. Decide to take it to criminal or tribunal side

Question 2

Competition Act:
Criminal Policies (Part VI)

Answer 2

• Sec. 45 – Conspiracy
• Sec. 47 – Bid Rigging
• Sec. 50-51 – Repealed (Price Discrimination, Predatory Pricing)
• Sec. 52-55 – Unfair business practices (false/misleading information)

Question 3

Competition Act:
Civilly Reviewable (Part VII.I)

Answer 3

• Sec. 74.01-74.06 – Bait and Switch
• Sec 75. – Refusal to deal
• Sec 76. – RPM (Resale price maintenance)
• Sec. 77 – Exclusive dealing, tied selling, market restriction
• Sec. 78-79 – Abuse of dominance
• Sec. 90.1 – Agreements
• Sec. 91 – Merger

Question 4

R.H. Coase - Why Do Firm’s Exist?

Answer 4

1. Firms engage with other markets
2. Using the market is costly
3. Transaction costs - reaching agreements, finding the appropriate price
4. Economize on transaction costs

Question 5

Alchian & Demsetz - When do firms exist?

Answer 5

Firms will exist whenever cooperative or joint group effort results in a larger product than the sum of individual isolated efforts - “team productive activity”

Question 6

Professor’s View of Firms:

Answer 6

Presence of appropriable specialized quasi-rents produce a serious threat of reneging on a contract

• Specialized assets create quasi-rents or surplus
• Gives rise to the possibility of opportunistic behaviour

Question 7

Quasi Rent

Answer 7

Difference between total revenue (TR) and total variable cost (TVC)

Question 8

Transactions Cost Approach of O. Williamson

1.) Bounded Rationality

Answer 8

Economic actors are intendedly rational, but only limitedly so. (incomplete contracting)

Question 9

Transactions Cost Approach of O. Williamson

2,.) Opportunism

Answer 9

Self-interest seeking with guile - deceitful cunning

Question 10

Vertical Integration

Answer 10

The combination in one company of two or more stages of production normally operated by separate companies

Question 11

Behavioural Theroies - Managers

Answer 11

Managers in charge of different functions within the firm may have different goals

Interest might not be the same as the shareholders interest

Question 12

Sales Maximization vs. Profit Maximization

Answer 12

There may be a sales target that sales employees have to reach, so they would be inclined to utilize sales maximization in order to reach their own compensation, as opposed to profit maximization which would help the firm as a whole.

Firms however are assumed to be profit maximizing

Question 13

Function of Maximization:

Answer 13

Max U = max U (S, m, Πr – Π0 – T)      S.T. Πr ≥ Π0 – T
•	S = staff
•	M = managerial emoluments 
•	Πr = reported profit
•	Π0 = Min profit demanded
•	T = tax

Question 14

Rule of Thumb Pricing

Answer 14

• Sometimes, firms don’t look like they’re maximizing profits, because they are not choosing a price that would lead you to believe that they are.

certain percentage markup for retail products - faster and easier way of setting price

Question 15

Opportunity Cost

Answer 15

The value of the resources used to produce a good in the best alternative use

Question 16

Avoidable Cost

Answer 16

Variable costs and product specific fixed costs that are not sunk

Ex.) tractor and ten other products
Owner: am i making enough money with this tractor to cover the costs of making the tractor

Question 17

Sunk Costs

Answer 17

Costs that cannot be avoided (depends on short or long run)

Ex.) Fixed costs
Ex.) Machine with no alternative use
Ex.) 1 year lease of building (in short run it is sunk)

Question 18

Common Costs

Answer 18

Factory costs that continue to incur, even if you shut down production of a specific product
Ex.) Lighting, heating of building, security

Question 19

Redeployment

Answer 19

Sublet a leased building to another user (fixed cost that is avoidable)

Question 20

Predatory Pricing

Answer 20

the pricing of goods or services at such a low level that other suppliers cannot compete and are forced to leave the market.

When testing if a firm is committing predatory pricing, you have to know what the avoidable costs are for a firm

Question 21

Long-Run Per-Unit Cost Curves for a Hypothetical Firm

Answer 21

• Because there are no fixed costs in the long run, there are only two per-unit cost curves: the long run marginal cost (LRMC) and the long run average cost (LRAC) curves. The shape of the LRAC curve is determined by returns to scale. LRMC intersects LRAC at the minimum of LRAC

Question 22

Economies of Scale

Answer 22

A proportionate saving in costs gained by an increased level of production

In microeconomics, economies of scale are the cost advantages that enterprises obtain due to size, output, or scale of operation, with cost per unit of output generally decreasing with increasing scale as fixed costs are spread out over more units of output.

Question 23

MES = Minimum Efficient Scale

Answer 23

• 1st minimum in LRATC
• In industrial organization, the minimum efficient scale (MES) or efficient scale of production is the lowest point where the plant (or firm) can produce such that its long run average costs are minimized.

Question 24

Sources of Scale Economies:

Product Specific

Answer 24

1. Length of production run – lower average set up costs (like a fixed cost)
2. Quality control
3. Learning by doing – more efficient that workers who are employed become

Question 25

Sources of Scale Economies:

Plant Specific

Answer 25

1. Economies of massed reserves – savings in the proportion of required reserves to expected output, as the scale of a facility increases (spare machines, labour)
2. Indivisibility – associated with K (nuclear power plant is large, so you have to produce large amounts of energy)
3. Specialization of labour

Question 26

Sources of Scale Economies:

Multi-Plant Scale Economies

Answer 26

Many firms produce multiple products in multiple plants

1.) Scheduling/Coordination - marketing costs (2 different products under the same brand… washer dryer…), distribution costs, financing costs