Firms and Decisions

Question 1

Definition of Explicit costs

Answer 1

Explicit cost is the firm’s actual cash payments for its inputs supplied by other firms.

Question 2

Definition of Implicit costs

Answer 2

Implicit cost is the cost of non-purchased inputs such as the opportunity cost. There is no involvement of direct payment. Eg. opp cost.

Question 3

Define Marginal Cost

Answer 3

Marginal Cost is the additional cost the firm incurred by selling one more unit of output.

Question 4

Describe the decision making of firms if they should expand/maintain/reduce production.

Answer 4

When MR<MC, the revenue generated exceeds the cost incurred from producing and selling the last additional unit of output. Thus, producers can increase their profits further by producing and selling more. The firm should expand production to increase profits. Hence, the production level of products should increase if its marginal revenue is greater than its marginal cost.

When MR>MC, the cost incurred exceeds the revenue generated from producing and selling the last additional unit of output. Thus, producers can increase their profits further by producing and selling less. The firm should reduce production to increase profits. So, production of burgers should decrease if marginal cost is greater then marginal revenue.

When MR=MC, the revenue generated equals the cost incurred from producing and selling the last additional unit of output. Hence, optimal level of production of burgers that maximises profits s found where MR=Rising MC.

Question 5

Why may firms be reaching satisfactory out comes rather than best possible outcome?

Answer 5

Profit satisficing behaviour arises due to the separation of ownership and management. As information is imperfect, owners may not know what the maximum level of profits could be. Hence managers may aim for output is just enough to satisfy the owners rather than maximise profits.

Firms may also be satisfied with profit satisficing level of output to avoid undue stress or challenges from expansion. This may be the case where stakeholders of the firms are not involved in the operations.

Question 6

What is the impact of Predatory pricing on other firms?

Answer 6

Other firms who are unable to match the price reduction will start to lose market share especially if the goods sold are close substitutes where XED>1.

Leading to a more than proportionate decrease in the demand for a firms to a large proportion, there will be a decrease in revenue and hence lesser profits. (May result in competitor firms to shut down)

Question 7

What is the impact of Predatory pricing on the firm?

Answer 7

Charging a price lower than the average variable cost would mean that the total revenue earned would be unable to cover the total cost incurred. Firms will suffer from losses in the short run. (P<Average variable cost = AR<Average variable cost)

Strategy can only be used by firms that has sufficient past profits to cope with the short-run losses incurred and depends on the capital available in the competitors to compete against the predatory pricing.

Question 8

What is the impact of Product differentiation on other firms?

Answer 8

Other firms will need to spend huge amount of advertising or product research and development to at least compete on equal footing.

Firms who are unable to bear the costs of doing so will lose market share.

Question 9

What is the impact of product differentiation on the firm?

Answer 9

Ability of firms to meet the taste and preferences of consumers and the ability to diversify the range of products in attracting a new group of consumers and expanding the market to gain an even greater share in the market.

Question 10

What is a variable factor of production?

Answer 10

It is a factor of production whose quantity can be varied within a given time. Eg. Labour

Question 10

What is a fixed factor of production?

Answer 10

It is a factor of production whose quantity cannot be varied within a given time period. Eg. capital and land.

Question 11

What is the impact on firms that use market share dominance strategy in the long run?

Answer 11

Increase in market share, make demand more price inelastic -> able to set higher prices -> leading to a less than proportionate decrease in quantity demanded -> increase total revenue.

Question 12

Define Long run

Answer 12

It is the time period in which there is no fixed factor of production, all factors of production are variable.

Question 13

Define Short run

Answer 13

Short run is a time period in which production process has at least one fixed factor of prodction.

Question 14

Define Average cost

Answer 14

It is the cost incurred per unit of output produced.

Question 15

Define Average Variable Cost

Answer 15

The average cost of production is the amount of variable costs incurred per unit of output produced.

Question 16

What does LRAC show?

Answer 16

LRAC shows the minimum cost per unit of producing a given output level when all factor inputs are variable.

Question 17

What are the 3 segments of LRAC called?

Answer 17

Internal economies of Scale, Minimum efficient scale, and Internal diseconomies of scale.

Question 18

What does internal economies of scale indicate

Answer 18

It refers to firms experiencing a fall in long-run average costs as output increases.

Question 19

What does minimum efficient scale indicate?

Answer 19

Average costs remain constant as output changes; point a, where long-run average cots first reach its minimum

Question 20

What does Internal diseconomies of scale indicate?

Answer 20

It refers to a rising long-run average costs as output increases.

Question 21

Define technical economies of scale

Answer 21

It refers to the rise in productivity, which lowers the unit costs and hence average costs savings experienced as the firm’s scale of production will increase in firm size. (efficiency)

Question 22

How do firms achieve technical economies of scale ?

Answer 22

By specialisation and division of labour. Specialisation allows production processes to be broken down into simpler processes thereby raising productivity and lowering the average cost of production as output increases. (max efficiency is achieved)

Question 23

How do firms achieve marketing economies of scale?

Answer 23

Firms engage in bulk purchase as they usually purchase raw materials in large quantities and can enjoy larger discounts leading to lower input prices and lower average costs as output increases.

Question 24

How do firms achieve financial economies of scale?

Answer 24

As firms expand production, they are often able to get bank loans at lower rate of interest compared to when they were smaller in scale. This is because banks generally consider larger firms to be less risky as they are more trustworthy. This leads to lower cost of borrowing. When this happens, the firm’s average cost of production falls.

Question 25

How do firms experience internal diseconomies of scale through poor coordination, high cost of monitoring and management?

Answer 25

As firms grow larger, they may be subdivided into many specialised departments, which increase the likelihood of communication breakdown, making task coordination more inefficient. This may result in wastage of resources on monitoring and management and an increase in average cost of production.

Question 26

How does lack of motivation and low morale lead to internal diseconomies of scale?

Answer 26

As firms grow larger, worker may not feel loyal to the firm as they may feel that are an insignificant part of the large firm. Impacting productivity and increase average cost of production as they may tend to be absent and low productivity, thus incurring higher average cost of production.

Question 27

Define external economies of scale.

Answer 27

It refers to a reduction in average costs, or cost per unit of production, because of the expansion of the industry.

It external economies of scale arise from the sharing of common resources between firms and outsourcing of production processes to supporting firms, due to industry expansion.

Question 28

How does economies of information: availability of shared resources lead to external economies of scale?

Answer 28

Through development of research facilities as the industry grows, firms may combine efforts to engage in research to develop better methods and products of higher quality. ->lower unit cost of production.

Through sharing of common knowledge, as the industry expands the pool of knowledge in the industry expands.

Question 29

How does economies of concentration: availability of infrastructure lead to external economies of scale?

Answer 29

Due to concentration of industry in the region, more and better facilities such as transport, banking and communications may be set up to meet the needs of the industry resulting in cost savings.

Question 30

Define external diseconomies of scale

Answer 30

External diseconomies of scale refers to a rise in average cost, or cost per unit of production, because of the expansion of the industry.

Question 30

How does shortage of industry-specific resources occur lead to external diseconomies of scale?

Answer 30

As industry expands, many firms will begin competing for the same factors of production, (labour that has a similar skill, with a rise in demand, the firms will have to offer higher wages to attract new workers) leading to increase in average costs of production.

Question 31

How does increased strain n infrastructure occur lead to external diseconomies of scale?

Answer 31

When too many firms are set up within the same area, roads may be overly utilised causing road congestion which results in increase transportation costs resulting increase in average costs of production.