Chapter 3 - Firms Flashcards
production function
the mapping that tells us, for a given set of inputs, how much output a firm is able to produce
isoquant curves
combinations of inputs that lead to a given level of output
perfect complements (isoquants)
A perfect complement is a good that must be consumed with another good.
L-shaped isoquants
perfect substitutes
A perfect substitute is a situation where two goods are viewed as identical, both give you the same output
straight isoquant
Cobb-Douglas production function
q=K^α L^β
intermediate case for inputs: neither perfect compliments nor perfect substitutes
law of diminishing marginal returns
for a given output level, using less L leads to need to use more K to compensate for the decrease in L; and the further decrease in L, the greater the increase in K is required to compensate for the decline in L.
Reflecting marginal returns, isoquants are ** curves; the closer compliments two inputs are, the more ** the corresponding isoquants are
convex
Total factor productivity
q = ω K^α L^β
given two firms with the same quantity of inputs, the firm with a higher ω is able to produce a higher output level
cost minimization
given a desired output level and given input prices, we determine the input mix that minimises cost
cost minimization = utility minimization
consumers seek the highest utility level consistent with a certain budget set; firms seek the lowest cost consistent with a certain output level (tangency)
production function is close to perfect complements
increase in cost of capital leads to a lower demand for labor
negative cross price elasticity
production function is close to perfect substitutes
increase in the price of capital leads to a higher demand for labor (positive cross-price elasticity)
cost function
shows the least total cost of inputs the firm needs to pay in order to produce output q
different types of costs
fixed cost, variable cost, total cost, average cost, marginal cost
(1) is the appropriate cost concept to decide how much to produce, whereas (2) is the appropriate cost concept to decide whether to produce at all
(1) marginal cost
(2) average cost
incremental revenue
the difference between total revenue from selling one unit and total revenue from selling no units
the level of output should be chosen so that the value of incremental revenue is as close to incremental cost as possible
optimal pricing: calculus approach
the profit maximizing output level is such that marginal revenue is equal to marginal cost
Elasticity rule of optimal pricing (Lerner Index)
The lower the price elasticity of demand (in absolute value) the higher the price-cost margin should be set
The price-cost margin is usually taken as an indicator of market power because…
…the larger the margin, the larger the difference between price and marginal cost, that is, the larger the distance between the price and the competitive price.
price markup
k = (p-MC) / MC k = 1 / (-ϵ-1)
Agency theory
a principal who wants an agent to act in the principal’s interest but possesses less information than the agent
labor market discipline
since managers don’t stay with the same firm forever, they are interested in creating a reputation for being good managers. This reputation effect may help provide mangers with the proper incentives
product market discipline
when product market competition is very intense, managers have to put more effort in maximizing profits. Competitors provide useful signals about the firm’s productivity, so they reduce the shareholder’s information disadvantage with respect to the manager.
capital market discipline
if a manager does not maximise profits, then the value of the firm is lower than its potential. in that case a raider could acquire the firm, change management in order to maximise profits, and thus make a capital gain
horizontal extension of a firm
how much of a given product does a firm produce and how many different products it offers
vertical integration of a firm
how many stages of the production process take place within the firm
specific asset
an asset that is worth a lot less if not coupled with a particular asset
hold-up problem
once the buyer pays for the relationship-specific asset, the seller can charge a higher price
tapered integration
a given input is bought from an affiliated supplier and from an independent one
mix of vertical integration and market exchange
franchising
combines benefits of vertical integration (specific investments paid by mother company) with the benefits of vertical separation (franchisees retain most of the profit so they have an incentive to be efficient)
The horizontal boundaries of the firm are largely determined by cost considerations. The vertical boundaries result from the balance between investment incentives and performance incentives
impediments to imitation
allow some firms to perform persistently better than others
tacit knowledge
capabilities that are developed by experience and rarely written down, difficult to express formally
causal ambiguity
determine the strategic resource that a company has available to it
learning curve
A learning curve is a concept that graphically depicts the relationship between the cost and output over a defined period of time, normally to represent the repetitive task of an employee or worker.
the more units a firm produces, the lower the cost of producing said unit (moving down the learning curve)
