Chapter 3: Production Flashcards
Define average cost
Total cost divided by quantity
Define marginal cost
Cost of producing an additional unit, derivative of TC
Describe a typical cost minimisation problem
Minimize wL+rK s.t the constraint f(K,L)=Q
Profit maximising condition:
MR=MC
Define the elasticity rule of pricing
since P(1+(1/e))=MC, then (P-MC)/P = -1/e
What is another name for (P-MC)/P = -1/e
The margin or the Lerner Index
What is implied by the Lerner Index?
If elasticity is higher, then the margin is lower and vice versa.
Define the markup
(P-MC)/MC, or m= k/1+k where k= 1/ (-e-1)
Why might profit maximisation not necessarily be the aim of a corporation’s management?
Recall that shareholders are the ones who receive the benefits of profitability. Managers, on the other hand, are concerned with their payoffs.
However, due to labor market, capital market and product market discipline, firms are still inclined to maximise profits.
Define labor market, capital market and product market discipline.
Labor market discipline:
Imposed on managers who are inclined to maximise profits in order to maintain a good reputation in case of a job change
Capital market discipline:
Firms not maximising profits may become undervalued and therefore a target for a potential takeover from other firms
Product market discipline:
Firms not maximising profits through product sales cannot compete on a fiercely competitive market
What determines horizontal extension
Whether a firm can benefit from producing other products within the same stage of production, usually driven by the desire to minimise AC
What determines vertical extension
Whether a firm can benefit from having control over all stages of its production process, usually to avoid holdup or again to minimise AC
Why would a firm decide to engage in vertical integration?
- To prevent holdup
2. To create additional capacity for production in times of high demand
What are some examples of vertical integration?
The acquisition of specific assets i.e a car company acquiring a steel company in order to secure a steady supply of steel.
Franchising: a hybrid of vertical integration and separation.
