Chapter 3 - Firms

Question 1

production function

Answer 1

the mapping that tells us, for a given set of inputs, how much output a firm is able to produce

Question 2

isoquant curves

Answer 2

combinations of inputs that lead to a given level of output

Question 3

perfect complements (isoquants)

Answer 3

A perfect complement is a good that must be consumed with another good.
L-shaped isoquants

Question 4

perfect substitutes

Answer 4

A perfect substitute is a situation where two goods are viewed as identical, both give you the same output
straight isoquant

Question 5

Cobb-Douglas production function

Answer 5

q=K^α L^β

intermediate case for inputs: neither perfect compliments nor perfect substitutes

Question 6

law of diminishing marginal returns

Answer 6

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.

Question 7

Reflecting marginal returns, isoquants are ** curves; the closer compliments two inputs are, the more ** the corresponding isoquants are

Answer 7

convex

Question 8

Total factor productivity

Answer 8

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

Question 9

cost minimization

Answer 9

given a desired output level and given input prices, we determine the input mix that minimises cost

Question 10

cost minimization = utility minimization

Answer 10

consumers seek the highest utility level consistent with a certain budget set; firms seek the lowest cost consistent with a certain output level (tangency)

Question 11

production function is close to perfect complements

Answer 11

increase in cost of capital leads to a lower demand for labor
negative cross price elasticity

Question 12

production function is close to perfect substitutes

Answer 12

increase in the price of capital leads to a higher demand for labor (positive cross-price elasticity)

Question 13

cost function

Answer 13

shows the least total cost of inputs the firm needs to pay in order to produce output q

Question 14

different types of costs

Answer 14

fixed cost, variable cost, total cost, average cost, marginal cost

Question 15

(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

Answer 15

(1) marginal cost

(2) average cost

Question 16

incremental revenue

Answer 16

the difference between total revenue from selling one unit and total revenue from selling no units

Question 17

the level of output should be chosen so that the value of incremental revenue is as close to incremental cost as possible

Question 18

optimal pricing: calculus approach

Answer 18

the profit maximizing output level is such that marginal revenue is equal to marginal cost

Question 19

Elasticity rule of optimal pricing (Lerner Index)

Answer 19

The lower the price elasticity of demand (in absolute value) the higher the price-cost margin should be set

Question 20

The price-cost margin is usually taken as an indicator of market power because…

Answer 20

…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.

Question 21

price markup

Answer 21

k = (p-MC) / MC
k = 1 / (-ϵ-1)

Question 22

Agency theory

Answer 22

a principal who wants an agent to act in the principal’s interest but possesses less information than the agent

Question 23

labor market discipline

Answer 23

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

Question 24

product market discipline

Answer 24

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.

Question 25

capital market discipline

Answer 25

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

Question 26

horizontal extension of a firm

Answer 26

how much of a given product does a firm produce and how many different products it offers

Question 27

vertical integration of a firm

Answer 27

how many stages of the production process take place within the firm

Question 28

specific asset

Answer 28

an asset that is worth a lot less if not coupled with a particular asset

Question 29

hold-up problem

Answer 29

once the buyer pays for the relationship-specific asset, the seller can charge a higher price

Question 30

tapered integration

Answer 30

a given input is bought from an affiliated supplier and from an independent one
mix of vertical integration and market exchange

Question 31

franchising

Answer 31

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)

Question 32

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

Question 33

impediments to imitation

Answer 33

allow some firms to perform persistently better than others

Question 34

tacit knowledge

Answer 34

capabilities that are developed by experience and rarely written down, difficult to express formally

Question 35

causal ambiguity

Answer 35

determine the strategic resource that a company has available to it

Question 36

learning curve

Answer 36

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)