Chapter 8 Flashcards
1
Q
Define a firm
A
A firm is an organization that combines all factors of production to produce a good or service that satisfies consumer needs and wants
2
Q
Factors that influence size of a business
A
- Nature of market
- Industry and sector
- Capital investment
- Technology
3
Q
Define short-run production
A
Increasing level of output by increasing the variable resources, but there must be at least one fixed F.O.P.
Usually, labour is the variable resource since it’s easy to hire more people.
But, capital is a fixed factor of production.
4
Q
Define long-run production
A
Increasing level of output by varying ALL quantities of factors of production; including both fixed and variable resources.
A firm is more flexible on the long-run, and can afford buying more machinery.
5
Q
Define production function
A
Relationship between input and output; it shows how the quantity of F.O.P is reflected back on level of output.
6
Q
Explain law of diminishing marginal returns
A
A law that states that if a firm constantly increases its input (mainly labour), there will be a point where the firm starts to gain decreasing levels of output. This might be due to overcrowding in work field.
This highlights importance of balance, excessive resources might lead to inefficiencies. (Unused labour)
7
Q
Define total costs
A
All costs incurred to produce a given level of output.
Fixed costs + variable costs.
8
Q
Define fixed costs
A
Costs that do not vary with level of output; no matter if the business is making profits or losses, they must be paid regardless.
Example: Rent.
**Opportunity cost is considered as a fixed cost.
9
Q
Define variable costs
A
Costs that vary with level of output; the higher the production levels, the higher the costs incurred.
Examples: Raw materials
10
Q
Define total revenue
A
Price x Quantity sold.
**Also, average revenue=price
11
Q
Define average revenue
A
Revenue gained per unit, which is equal to price.
**Marginal revenue falls more rapidly than average revenue.
12
Q
Define breakeven point
A
Point where no profits or losses are made; costs are equal to revenues.
13
Q
What are the short-run production costs?
A
- Average cost: Cost per unit
- Marginal Cost: Additional cost per additional unit produced[=1
**Marginal cost is related to marginal principle; where we see if it’s worth the cost to produce an addition unit - Marginal revenue: Additional revenue gained per additional unit sold.
14
Q
What are the long-run production costs?
A
- Increasing returns to scale: A percentage increase in input will lead to an even higher increase in the percentage of output.
- Decreasing returns to scale: A percentage increase in input will lead to a smaller percentage increase in output. (Law of diminishing marginal returns)
- Constant returns to scale: Percentage increase in input is equal to the percentage increase in output.
15
Q
Define normal profits
A
The return needed for a firm to be able to survive in the market on the long-run.
It is mostly earned in perfect competition, where there is a small gap between AC and AR because they’re perfectly elastic and have no influence over prices.
16
Q
Define supernormal profits
A
Profits gained above normal profits; there’s a huge gap between AC and AR.
It is mostly earned in monopoly markets as they can set very high prices as price maker and inelastic
17
Q
Define subnormal profits
A
Profits earned below normal profits, where business is making losses. This can be in a perfect competition market where there are high taxes, so they carry the burden.
18
Q
Define accounting profits
A
Calculation of profits excluding opportunity cost from the fixed costs as it’s not an explicit value.
19
Q
Shut-down price in the short run
A
On the short run, the business focuses on covering their variable costs. If the price paid per product does not cover the marginal cost, the business will shut down temporarily. They will stop selling only.
Price = MC/AC
**Can postpone fixed costs later
example: on the short run, a pizzeria must cover the cost of their ingredients to be able to operate.
20
Q
Shut-down price in the long run
A
On the long run, the business must cover all costs, both fixed and variable. If the price does not cover it, then the business will exit the market permanently.
They will stop selling their products, and will sell their business.
example: on the long run, pizzeria must cover both cost of ingredients AND rent and oven installments.
21
Q
Define economies of scale
A
An increase in scale of production will lead to a decrease in average costs paid per unit.
22
Q
Define external economies of scale
A
Due to expansion of WHOLE industry
23
Q
Define internal economies of scale
A
Due to expansion of firm
24
Q
Examples of internal economies of scale
A
- Purchasing economies of scale: Purchasing in bulk will allow the firm to get discounts
- Technical E.O.S: The firm is capable of affording specialists and high-tech machinery due to high budget.
- Marketing E.O.S: The firm can split the cost of advertisement onto multiple products. There will be lower costs per unit.
- Financial E.O.S: Banks will be more willing to offer lower interest rates when taking big loans.
- Diversification
25
Examples of external economies of scale
- Shared R&D department costs
- Joint marketing benefits, like when complementary goods make ads together. (Chipsy and Pepsi)
26
Define diseconomies of scale
An increase in scale of production will lead to a higher average cost; this is due to higher inefficiency. (Excessiveness)
27
Examples of internal diseconomies of sccale
- Low morale: There's a large number of employees, so the employee might feel demotivated and less productive as they feel they have no actual significance in work.
- Managerial: There might be miscommunication and poor management across multiple branches, leading to more wastes and losses.
- Agglomeration: Loss of focus and control when diversifying.
28
Examples of external diseconomies of scale
- Traffic congestion due to lack of infrastructure
- Pollution
- Lack of resources in country
29
Define minimum efficient scale
Level of output at which long-run average costs stops falling as output increases
30
Define market structure
Market environment in which firms operate in terms of number of firms and barriers of entry.
31
Determents of market type
- Number of firms
- Nature of product
- Barriers of Entry
- Elasticity
- Ability of firms to set prices
32
Define perfect competition
Perfect competition is a market where there are hundreds of firms selling identical products with no product differentiation whatsoever. They make normal profits; just enough to cover their costs. They are price takers as they have no influence of market price.
*It exists due to subsidies.
ex: soo2 el khodar
33
Characteristics of perfect competition market
- 100s of sellers
- Selling identical products
- Perfectly elastic supply due to high number of firms
- Price takers as there is no product differentiation
- No barriers of entry
- Normal profits made on long-run
- Allocatively efficient.
- Exists due to subsidies
- Perfect knowledge
34
Define monopolistic competition
Market with multiple sellers that sell similar products; firms try to gain a competitive advantage by investing in advertising to develop brand loyalty and have the capability to influence price-- product differentiation.
ex: food court
**Average costs may increase on the long run due to excessiveness in advertising costs, causing AC to shift up.
35
Characteristics of monopolistic competition
- Multiple sellers
- Similar products
- Product differentiation is present
- Low barriers of entry and exit
- Price takers
- Price ELASTIC demand
- No dominant firm
36
How can product differentiation be achieved?
Through advertising and branding to distinguish itself from others to have a unique selling point.
37
Define a contestable market
Market where people can enter and exit freely. Hit and run strategy is most implemented in this market.
38
Characteristics of a contestable market
- No barriers of entry and exit
- No sunk costs: money that has been pain and cannot be recovered.
- Perfect knowledge
39
How is a contestable market achieved?
- No brand loyalty, so customers are willing to try other places.
- No R&D department costs, so no sunk costs.
- Government offers subsidies
- No economies of scale.
- No patents in market.
40
What is the hit and run strategy?
This strategy is mainly used in contestable markets, where firms take advantage of the raise in prices and supernormal profits and enter the market to benefit, but then exit it once profits diminish without paying any costs or struggling.
41
Define oligopoly
A market dominated by 2-3 sellers, where when making economic decisions the firm must take into account rivals' decisions and reactions.
**Market is interdependent.
42
Characteristics of oligopoly market
- 2 to 3 sellers
- Price inelastic demand
- Prime makers (price leadership)
- High barriers of entry
43
Non-price competition
Firms in an oligopoly against one another through advertising to develop brand loyalty or design and packaging rather than relying on price.
44
Non-pricing strategies
- Advertisement
- Branding
- Product innovation
- Packaging
- Loyalty card system
45
Define game theory
A model that demonstrates how firms interact with one another in an oligopoly market, and how their actions affect overall outcome.
46
Define prisoner's dilemma
Refers to the idea of game theory, where in an oligopoly, firms only choose the best outcome for themselves and not considering others. However, the best outcome would be if these firms colluded through a tacit or cartel to maximize profits.
This can be seen through a kinked demand curve.
47
Cooperation and Collusion in oligopoly
- Cartel: Legal agreement between firms to fix prices and output to maximize profits.
- Tacit: Unofficial agreement between firms to fix prices.
- Split R&D department costs.
- Split market
48
Disadvantages of fixing prices through tacit or cartel
- Government may intervene and ban cartel or tacit
- If one firm withdraws, price wars will follow.
- Not always fair since firms may have different costs, yet earn the same revenue. Profits will differ.
49
Prisoner's dilemma explanation
It's a concept that explains why 2 parties might not work together even though it'd be the best outcome.
2 prisoners are arrested and interrogated separately. They can either confess on one another (betray) or stay silent (cooperate)
Both stay silent= 1 year jail (Small punishment)
Both confess= 5 years in jail (Moderate)
One confessed, and other stayed silent= One who confessed will be free and the one who remained silent will be prisoned for 10 years. (Heavy punishment)
Both parties try to act based on their best interests, so they both confess to save themselves as they're selfish and do not consider the other party.
If they had cooperated, they would've gotten the best outcome.
50
Relation of prisoner's dilemma to game theory.
It reflects self-interest vs cooperation; each party's best decision for themselves leads to a bad result for both. (Both confessing, so 5 years in jail).
Firms in an oligopoly face a prisoner's dilemma when it comes to picking a price, and choosing whether to compete or collude.
If both firms lower prices, they will enter a price war and profits will decrease.
If they raise prices together, they'll maximize profits.
However, they are constantly undercutting one another for their self-interest.
Both parties must collude through a tacit or cartel to maximize profits; this can be seen in the Kinked demand curve.
51
Define monopoly
One seller dominating whole market
52
Characteristics of a monopoly
- 1 seller
- Extreme barriers of entry
- Perfectly inelastic demand as there are no other competitors, so can pick any price along demand curve.
- Price maker
- Make supernormal profits
53
Benefits of monopoly
- Can fund R&D department and improve quality standards.
- Gains from economies of scale, so lowers costs and prices.
- In case of predator pricing, the price of product will be severely low.
- Natural monopolies are always beneficial to society as it's owned by public sector and aim for affordability
54
Harms of monopoly
- Sole seller in market, so can exploit consumer and set very high prices.
- Low consumer choice
- Quality drops due to low competition
- X-inefficiency: Firms become very inefficient and wasteful, which leads to an increase in costs, however the firm can pass on extra costs to customers by setting higher prices as inelastic demand.
55
How do firms grow?
- Internal growth
- External growth
- Diversification
56
Define internal (organic growth)
Business expands by reinvesting profits back into business. Like, opening new branches or hiring more labour.
**Controlled expansion, but may be slow since it's constrained by finance.
57
Define external growth
Business expands by taking over or merging with another firm.
**Instant expansion of market share.
58
What are types of external growth?
- Vertical Integration
- Horizontal integration
- Conglomerate Integration
59
Define horizontal integration
Business expands by taking over or merging with another firm that is in the same industry and stage of production.
A car manufacturer taking over another car manufacturer.
**Direct takeover
60
Advantages of horizontal ingtegration
- Reduces number of competitors in market
- Increased market share
- Increased influence over prices
61
Define vertical integration
Business expands by taking over or merging with another firm that is in the same industry but different stage of production.
There are two types: Forward and Backwards.
62
Define forward vertical integration
Business expands by taking over or merging with another business that is involved in a later stage of production
63
Advantages of forward vertical integration
- Assures outlets for distribution
- Prevents from selling competitor's products.
64
Define backward vertical integration
Business expands by taking over or merging with another firm that is involved in an earlier stage of production.
65
Advantages of backward vertical integration
- Higher control over supply, in terms of constant supply of raw materials, control over delivery time, costs, quality.
- Prevents from supplying to competitors.
66
Define conglomerate integration
When a business expands by taking over or merging with another firm that is in a different industry and stage of production.
67
Advantages of conglomerate integration
- Spread risks
68
General problems of growth
- Managerial D.E.O.S
- Loss of focus
- Communication problems
- Financial problems
69
How to solve problems of growth
- Managerial D.E.O.S= Hire a specialist manager
- Loss of focus= Avoid overdiversifying
- Communication problems= Regular meetings to keep everyone informed
- Financial problems= Steady growth
70
Explain principal-agent problem
Owners and managers have conflicting interests and objectives; managers aim for higher pay, while owners seek higher profits.
**Owners delegate tasks to managers
71
Define profit maximization
A firm may determine the price, input and output levels that will lead to the highest possible total profit.
MC=MR is the level of output that allows for profit maximization
**Long gap since low output, yet high profit margin.
72
Why do firms prioritize profit maximization?
- Satisfy owners
- Give shareholders higher shares.
- Internal growth
73
Disadvantages of profit maximization
- Overshadows other objectives like consumer satisfaction or employee welfare
- Risk of exploitation of both consumer and employee.
- Reduced quality to reduce costs as much as possible
- Setting high prices will be bad for customers.
74
Define sales revenue maximization
The firm sets the price strategically to earned highest revenue possible.
Rule: MR=0
**Wide profits because high output produced
75
Why do firms focus on Sales Revenue maximization?
- Economies of scale
- Focuses on gaining high revenues to meet financial obligations. (Cash inflow)
- Ignores profits and aims for revenues, sets prices strategically
76
Define sales volume maximization
Trying to sell highest quantity possible; this can be done by lowering prices.
Rule: AC=AR
Gap between cost and revenue is non-existent; almost no profits are made.
77
Why does a firm aim for sales volume maximization?
- Flood market to increase market share
- Brand awareness, and brand loyalty
- Get rid of unsold excess stock
- Breakeven
78
Disadvantages of SRM/SVM
- Short-term focus, might lead to a loss of customers.
- Lower profits
- Overproduction risks
- Quality reduced
- Inefficiency
- High revenue does not translate to high success
- Pressure on employees
79
Define satisficing
Sacrificing some of business profits to satisfy shareholders
80
Example of satisficing
Employee: Lower profits to give higher wages and salaries.
Shareholders: Lower profits to give higher dividends
Customers: Lower profits to give lower prices.
81
Define survival
Gaining enough to cover up costs; on the short-run, must cover variable costs. On the long run, must cover all costs.
82
Define ethical objects.
Related to CSR: corporate social responsibility firm takes into account the effect of its actions on the environment.
Must be renewable, ecofriendly and no consumer exploitation.
83
Define price discrimination
Sellers charge different customers different prices even though the same product is being sold.
If inelastic, charge higher.
If elastic, charge lower
84
Conditions to apply price discrimination
- Having sufficient market power to be able to influence price, like being a monopoly.
- Having perfect information be able to segment customers into different sub groups.
- Item cannot be resold to avoid arbitrage where customers who got the product for cheap sell it expensively to profit.
- Firm must be a price-maker and aware of elasticities
84
How can price discrimination benefit producers?
The 1st degree can allow them maximize profits by setting highest price.
The 3rd degree can allow them to charge higher prices for specific subgroups, like people who live in more posh areas will be more profitable.
84
Degrees of price discrimination
1st degree: Firm charges highest maximum price to be able to capture consumer surplus and maximize profits.
2nd degree: Firm charges customers different prices according to the number of units they've purchased.
3rd degree: Firm charges customers different prices according to their social groups. Like, charging students less or "pink tax".
85
How can price discrimination benefit customers?
2nd degree can allow customers who purchase in bulk get discounts.
3rd degree can allow specific groups of people to earn the product for cheaper, like low income groups pay less.
86
Evaluation of price discrimination
- Not practical in real life because one of the conditions is that it cannot be resold, and it's hard to control that in an open economy.
- Exploits consumer heavily
- Can easily be prevented by government
- A pure monopoly is only theoretical.
87
Define limit pricing
Highest price a firm can set, just below profit-maximation price, without enabling new firms to enter market to make profits
88
Define predatory pricing
A strategy in which a farm sets a price that is below average costs to force newly-established rivals out of the market to achieve dominance.
89
Define price leadership
A form of tacit or collusion that allows firm to fix prices without formally communicating.
90
What are the artificial barriers of entry?
- Predatory pricing
- Exclusive dealings with suppliers
- Patents
91
What are the natural barriers of entry?
- Economies of scale
- Reputation
- Capital investment
92
Define n-concentration rato
Measures market share of the largest n-firms in industry, in terms of output or employment.
