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y1 of l&e > Economics Stage 3 > Flashcards

Economics Stage 3 Flashcards

1
Q

What is a Firm in Economics and what is their purpose?

A
  • Firms are social institutions which combine Factors of Production (FOPs) in order to produce goods or services for sale in markets.
  • Firms have a primary objective to maximise profits.
  • If a firm does not profit maximise they risk the cessation of trading.
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2
Q

What is the term used to describe using a FOP?

A

Opportunity Cost (OC).

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3
Q

How do OC’s relate to a Firm?

A

OCs to a firm come in two types:

▪ Explicit OCs– costs paid in money by the firm for FOPs such as wages, materials, and rent.

▪ Implicit OCs– the value of forgone alternatives such as renting equipment out for other purposes and normal profit (i.e. cost of entrepreneurial ability).

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4
Q

How is Economic Profit calculated?

A

Economic Profit = Total Revenue - Opportunity Cost
Explicit Costs + Implicit Costs Sales * Price

  • Economists and accountants differ in their
    definition of profit.
  • Accounting Profit only considers explicit costs.
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5
Q

What must a Firm consider in order to maximise profit?

A

▪ What to Produce– the types of goods and services to produce with the FOPs and in what quantities.

▪ How to Produce– the manufacturing process to follow.

▪ Management– the organisation and renumeration of labour.

▪ Marketing– the advertisement and price strategy for the goods and services produced.

▪ Suppliers– what FOPs to buy-in and what to produce in-house.

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6
Q

What are the three forms of Constraints that affect FOP’s?

A

Technology Constraints.

Information Constraints.

Market Constraints.

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7
Q

What is the meaning of Economical and Technological efficiency?

A

▪ Technological Efficiency– producing output with the fewest inputs.

▪ Economic Efficiency– producing output at the lowest cost.

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8
Q

What is a Command System?

A
  • A hierarchy is implemented in the firm where managers direct the activity of subordinates.
  • Orders are passed from mangers to subordinates.
  • Information is passed from subordinates to managers.
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9
Q

What is an Incentive System?

A
  • The renumeration of staff is directly affected by performance.
  • Performance on key metrics is measured and staff are rewarded for their contributions (e.g. sales bonus).
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10
Q

What is the Principal Agent Problem?

A

The Principal-Agent-Problem denotes to difficulties that principals (e.g. owners) have with ensuring agents (e.g. workers) perform in the best interests
of the firm.

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11
Q

What three options solve the Principal Agent Problem?

A

▪ Part Ownership– agents are provided with a stake in the firm (e.g. shares) and benefit from the profits made by the firm.

▪ Incentive Pay– the wage an agent receives is linked to their job performance.

▪ Employment Contracts– agents are awarded permanent contracts which provide career progression.

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12
Q

What determines the type of Market?

A
  • Five different types of market structure are generally defined, each with different levels of market power for the firm.
  • These market structures are defined by:

▪ The number of firms which are present.

▪ The number of consumers that are present.

▪ The degree of information held by the firms and consumers.

▪ The ease of entry and exit.

▪ The type of good produced.

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13
Q

Name as many market types as possible.

A

Perfect Competition, Monopolistic Competition, Monopoly and Oligopoly.

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14
Q

What is Perfect Competition?

A
  • This market has many firms and consumers.
  • The firms produce homogenous goods (i.e.
    highly similar).
  • Barriers to entry and exit are low.
  • Firms and consumers have complete
    knowledge of the prices charged.
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15
Q

What is Monopolistic Competition?

A
  • Similar to perfect competition.
  • Firms differentiate their products from their
    competitors (e.g. heterogeneity though
    branding).
  • This provides firms with a monopoly other their
    product variant.
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16
Q

What is an Oligopoly?

A
  • This market has few firms and many
    consumers.
  • The firms may produce homogenous or
    heterogenous goods.
  • Barriers to entry and exit are high.
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17
Q

What is a Monopoly?

A
  • A sole firm supplies the majority of the market.
  • No close substitutes for the product supplied
    are available.
  • Barriers to entry and exit are high.
18
Q

What is the concentration ratio?

A
  • One measure which helps to distinguish market structure is the concentration ratio.
  • This ratio measures the percentage of the market controlled by the largest 5 firms.
  • Market control can be considered in different ways, such as number of employees, number of sales or total revenue.
  • This ratio does have a number of limitations.
19
Q

What are the limitations of the concentration ratio?

A

▪ Geographical Scope– the reach of the market e.g. regional, national, or international.

▪ Contestability– some markets may have few firms but new firms can enter easily if opportunities are present.

▪ Multiple Markets– some firms operate in different markets with different levels of integration.

20
Q

What are Timescales?

A
  • To determine how to produce a given output, a firm must be aware of the cost implications of alternative approaches.
  • These cost implications are generally considered over two timeframes:

▪ Short-Run: the quantities of some FOPs available to firms are fixed (e.g. capital such as machinery, land such as factory space) while others are variable (e.g.
labour). These fixed FOPs are often referred to as a firm’s plant.

▪ Long-Run: the quantities of all FOPs are variable.

21
Q

What is Short-Run Product?

A
  • To increase output in the short-run, a firm must increase its use of one the variable FOPs (e.g. labour).
  • To understand how this increase in FOP use impacts output, three ways of measuring output are useful.
22
Q

What are the 3 ways of measuring output?

A

▪ Total Product (TP)– measures the output of goods produced by a firm for a given input of FOP.

▪ Marginal Product (MP)– measures the change in the output of goods produced by a firm given a one unit change of FOP input.

▪ Average Product (AP)– measures the mean output produced per unit of FOP input at a given output level (i.e. total output divided by total FOP input).

23
Q

What are Price Takers in a Perfect Competition (PC) market?

A

Firms in a PC market accept the market price for a good– they are said to be price takers.

24
Q

How do Price Takers affect a PC?

A

Small Scale Production:

  • PC firms only produce a small fraction of the overall output of a market.
  • PC firms can sell all of the output they want at the market price.
  • If a PC firm was to double its output, it would have a minuscule effect on the overall QS in the market.

Homogenous Products:

  • PC firms sell an identical product to a market (i.e. there is no diversification).
  • Buyers are fully aware of the market price.
  • If a PC firm was to increase its price, consumers would simply purchase their product
    from another firm.
25
Q

How does a PC market value revenue?

A
  • A PC firm has a goal to maximise the economic profit which it makes.
  • Economic profit is experienced when a firm’s TR > TC.
  • Normal profit is included in the firm’s TC as an OC.
  • The TR received by a PC firm is the quantity of a good it sells multiplied by the market price of the good:

TR = Market Price * Quantity Sold

AR = TR/Quantity Sold

MR = ∆TR/ ∆Quantity Sold

26
Q

How will a PC firm strategise in its market?

A
  • A firm in a PC market will not alter the price at which it sells its goods.
  • The firm can only change the quantity of goods it sells in the PC market.
  • How does a firm decide what quantity of goods to sell?
  • A firm will sell the quantity of goods at which it maximises profits.
  • Decisions can be taken across two timeframes.
27
Q

What two timeframes affect a PC firm?

A

Short-Run:

  • Whether to operate or hibernate.
  • What quantity to sell in the market.

Long-Run:

  • Whether to operate or exit the
    market.
  • Whether to increase or decrease the
    plant size.
28
Q

What is PC profit maximisation?

A
  • One method to identify the profit maximisation
    point for a firm operating in a PC market is to
    examine the TR and TC curve.
  • Profit maximisation occurs when a firms TR exceeds
    its TC by the largest amount.
  • A second method to identify the profit maximisation point for a firm operating in a PC market is to examine the MR and MC cost.
  • Profit maximisation occurs when a firms MR = MC.
29
Q

What is Short-Run Operation in a PC Market?

A
  • The price a firm operating in a PC market receives may vary in the short-run due to such issues as seasonality or supply shocks.
  • In the short-run, a firm operating in a PC market can:
  1. Make an economic profit– TR exceeds TC.
  2. Break-even– TR = TC and normal profit is made.
  3. Make an economic loss– TC exceeds TR.
30
Q

Why is Short Term loss in a PC Market?

A
  • A firm in a PC market may continue to operate
    even if it is making an economic loss in the
    short term
31
Q

What is Long Run Operation in a PC Market?

A
  • In the long-run, a PC market can adjust to situations in the following ways:
  1. Firms can exit or enter the market.
  2. Firms can change their plant size.

Example– Firms Making Economic Profit:

  • A PC market has a price which exceeds the ATC of most firms operating in it.
  • Firms in the PC market are making an economic profit.
  • As there are no barriers to entry, new firms enter the market in the search for
    profit.
  • The market’s supply curve shifts to the right.
32
Q

What is Long Run Plant Expansion in a PC Market?

A
  • If a firm operating in a PC market is making an
    economic loss they may be able to expand their
    plant size to lower their ATC and MC.

This assumes that the firm is not operating at
the most efficient point on their LRAC curve.

If making an economic loss, they must:

  • They decide to increase their plant size by
    purchasing new machinery (i.e. increase capital).
  • Both the MC and ATC curves shift rightward and
    the firm now profit maximises at point C.
33
Q

What causes a permanent change in demand within a PC Market?

A

The demand for goods traded in PC markets may be permanently changed due to:

▪ Changes in tastes and preferences amongst consumers.

▪ Changes in population and income levels.

▪ Changes in the price of related goods.

34
Q

How does permanent change affect a PC `market?

A
  • These changes would have the effect of shifting the demand curve in the PC market.
  • Shifts in the demand curve would disturb a PC market which is currently in long-term equilibrium.
35
Q

What is a Monopoly Market?

A
  • A monopoly is a firm that faces no competition within its market and has the ability to apply market power.
  • Two conditions often lead to the occurrence of monopoly.

▪ No Close Substitutes– no other good provides a similar function to that produced by the monopoly.

▪ High Barriers to Entry– entering the market in which the monopoly operates is difficult.

o Legal Barriers– can take the form of exclusive rights or licenses to operate (e.g. DNOs are granted regional monopolies) or the use of patents to protect
intellectual property and promote innovation (e.g. the development of new medicines).

o Natural Barriers– economies of scale within the market are large allowing a sole producer to offer a price which new firms cannot compete with.

36
Q

What is the Monopoly Strategy?

A
  • As the monopoly is the sole provider in the
    market, they face the market demand curve.
  • A monopoly has the ability to set either:

▪ The price it sells its good.

▪ The quantity of goods it sells.

37
Q

What is the Monopoly Market strategy?

A
  • A monopoly faces similar cost functions to those
    present in a PC market.
  • The profit maximisation point is where MR = MC
    = Point A.
  • The economic profit derived from a monopoly is
    affected by their ATC.
38
Q

How does a Monopoly operate in a PC Market?

A
  • If the market was operating in PC, a firm’s MR
    would be derived from the market demand
    curve.
  • Consumer surplus is the difference between
    what a consumer would be willing to pay
    compared to what they did pay.

When a monopoly enters the market the consumer surplus therefore decreases.

This causes the excess surplus to be redistributed to the Monopoly.

Thus proving Monopoly Market structures are inefficient.

39
Q

How does a Monopoly Market structure affect Price Discrimination?

A
  • So far, we have assumed that the monopoly applies a single price in the market.
  • The market power of monopolies allows them to practice price discrimination.
40
Q

What is Price Discrimination?

A
  • Price discrimination is where a firm offers a different price to different types of consumer (i.e. some face lower and others face higher prices than the market price).
  • The application of price discrimination requires a few conditions.

▪ The firm can distinguish different types of consumer.

▪ The firm has knowledge of how much each type of consumer is willing to pay (WTP) for the good.

▪ The good sold by the firm cannot be easily re-sold.

  • Firms which practice price discrimination have the ability to further extend their profits.
41
Q

How does market research of consumers affect Price Discrimination?

A
  • A monopoly conducts some market research and
    identifies three consumer groups with different WTP.

▪ The first group are employed consumers that
have a WTP of 8.

▪ The second group are retired consumers that
have a WTP of 6.5.

▪ The third group are student consumers that have
a WTP of 5.

  • By charging different prices to these consumer groups the monopoly has been able to further capture the consumer surplus.
42
Q

What benefits are there for the Monopoly Market Structure?

A
  • Given the comparison between a PC market and a monopoly, it can be easy to assume that
    monopolies are bad and PC is good.

Economies of scale and scope:

  • However, there are two particular benefits that a monopoly market structure can offer economies of Scale and Scope.

▪ An economy of scale occurs when the ATC falls as output expands while an economy of scope occurs when the ATC falls as output diversifies.

▪ Monopolies are better positioned to achieved economies of scale and scope due to their
high levels of output.

Research and Development:

▪ The economic profit earned by a monopoly can be investing into R&D activities.

▪ The granting of patents encourages these R&D activities.

▪ If many firms in a PC market are conducting R&D, then it could lead to replication of effort.

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