firms and decisions Flashcards
get funky
1
Q
what is the traditional objective of firms?
A
maximise profits by producing until MR=MC (profit-maximising condition)
2
Q
define profit
how is pricing and output decision made?
where is profit maximising output?
A
profit: TR-TC
Marginalist Principle, MR=MC
profit maximising output is at MR=MC
3
Q
what are the alternative objective of firms? (4)
A
- profit satisficing
- principal agent problem –> management lacks info on max level of profits compared to owners –> makes min amount of profits that satisfies - revenue maximisation
- maximise revenue without considering costs (p-a problem) - market share dominance
–> reduce PED to set higher prices –> increase revenue –> increase profits - social and environmental
- altruistic objectives for societal welfare
4
Q
firms may lack sufficient or accurate information to make price and output decisions to maximise profits.
true or false
A
true
5
Q
define total cost, average cost, and marginal cost
A
SR: total cost = total fixed cost + total variable cost
LR: total cost = tfc
average cost= TC/TQ
marginal cost: additional cost of producing an additional unit of good (change in TC/change in Q)
6
Q
define total revenue, average revenue, marginal revenue
A
total revenue= P x Q
avg revenue = TR/TQ
MR: additional revenue earned from producing additional unit of good
(change in TR/change in Q)
7
Q
distinguish fixed factor and variable factor input and hence distinguish fixed costs and variable costs
A
In the short-run, fixed factors are inputs that cannot be changed in quantity
within the time period. In LR, fixed factor inputs can become varied
Total fixed costs (TFC) remain the same
when output varies and are incurred even when output is zero.
Variable factors are inputs that can be changed within the time period. (in SR)
Variable costs increase as output increases and are not
incurred when output is zero.
8
Q
difference between sr production and lr production
A
Short-run production is when there is at least 1 fixed factor input.
In contrast, long-run production is when all factor inputs can be varied
9
Q
3 different kinds of profits + diagram
A
Normal (AC=AR), supernormal (AR>AC), subnormal (AC>AR)(refer to graph bank for diagram)
10
Q
what is increasing returns to scale
A
when output increases more than prop to an increase in factor input
LRAC falls as output increases, firm enjoys IEOS
11
Q
what is decreasing returns to scale
A
when output increases less than prop to increase in factor input
LRAC increases as output increases, experiences idos
12
Q
draw LRAC curve and what does it reflect? identity minimum efficient scale and what does it reflect?
A
reflects lowest possible cost of each quantity
MES: highest ieos, lowest LRAC
13
Q
draw lrac curve for substantial ieos and state characteristics
A
Industries that have high barriers to entry tend to consist of a few big firms each with
a large market share. There is thus significant IEOS to be reaped by firms in
such industry, and thus the MES is large relative to industry demand. As firm
increases its output there is significant cost savings i.e., total cost can be spread over a larger output. Hence the LRAC
falls over a large range of output.
14
Q
draw lrac curve for limited ieos and state characteristics
A
Comparatively, for industries that have low barriers to entry (such as
neighbourhood hair salon) due to reasons such as low start-up cost, tend to
consist of a many small firms and each firm only has a small market share.
There is thus limited IEOS to be reaped by firms in such industry, and thus the
MES is small relative to industry demand. Hence the LRAC falls over only a
small range of output as firms increases its production.
15
Q
define ieos and idos
A
ieos: unit costs reductions as a result of firm expanding scale of production
idos: unit costs increments as firm expands scale of productition
16
Q
when does ieos and idos arise
A
ieos:
1. spreading fixed costs
2. productivity improvements
3. greater buying power over inputs when production expands
idos
1. greater complexity and lower labour motivation
2. employment of more resource to manage problems
17
Q
sources of ieos
A
- technical economies (specialisation and div of labour which increases productivity, factor indivisibility which spreads out fixed costs over larger output)
- managerial economies –> specialisation of managers = more productive
- marketing economies, large scale of production –>bulk purchases = significant buyer = cost advantages
- financial economies: large firms have greater financial credibility, unit interest cost may fall
18
Q
sources idos
A
- over specialisation: monotonous work = less productive when disengaged
- managerial diseconomies
(communication challenges) = cost of managing
19
Q
define eeos and edos
A
eeos: unit cost reductions due to industry expansions
edos: unit cost increments due to industry expansions
20
Q
- sources of edos
A
- strain on infrastructure (congestion)
- strain on resources (demand for same set of resources increases)
21
Q
sources of eeos
A
- economies of concentration –> agglomeration –> lesser costs for all firms
- economies of info –> cooperate to r&d
- economies of disintegration
–> division of labour, offshoring
22
Q
shut down condition in sr
A
if AR cannot cover TVC
(revenue cannot cover at least variable costs)
TVC>AR –> shut down to minimise losses
23
Q
shut down condition in lr
A
AR<AC
24
Q
market structure characteristics
A
- level of bte (which affects others)
- number and size of firms
- nature of products
- access to information in the market
25
4 types of market structure from most competitive to least competitive
perfectly competitive, monopolistic competitive, oligopoly, monopoly
26
characteristics of pc
+ slope of DD curve
1. bte: none, complete freedom of entry and exit
2. very large number of small firms, every firm is a price taker
3. homogenous ( perfect subs)
4. perfect info
5. horizontal DD curve
27
characteristics of mpc
+ slope of DD curve
1. bte: low, freedom of entry and exit
2. large no. of small firms, no dominant firms
3. slight differentiated with many close subs
4. imperfect info
5. gentle sloping DD curve
28
define + characteristics of oligopoly (one of them is impt and unique to oligopoly)
+ slope of DD curve
1. bte: high, little freedom of entry and exit
2. a few large firms, that are MUTUALLY INTERDEPENDENT = HIGH RIVAL CONSCIOUSNESS
3. slightly differentiated/homogenous (will try to differentiate to reduce substitutability)
4. imperfect
29
types of bte
natural
1. start-up costs
2. financial credibility
man-made
2. access to inputs and resources larger firms may be controlling supply chain)
3. legal barriers e.g. patents that protect intellectual property rights, licenses, copyrights
30
characteristics of monopoly + slope of DD curve
1. bte, no freedom to entry or exit
2. one dominant firm
3. unique product, no close subs
4. highest degree of imperfect information
31
why do some firms practice price rigidity
A competitive oligopolistic market adopts price rigidity -- a scenario where
prices of goods and services are often observed to remain relatively unchanged
and seldom practices price competition (i.e., neither increase/decrease its price).
The underlying assumption is that rival firms will match each other's price
reductions but not each other's price increases. This highlights the concept
of mutual interdependence between oligopolistic firms and explains why
competitive oligopolistic firms seldom change prices even when production costs
may change slightly. Any attempt to reduce prices will be matched by rivals to retain market share
resulting in a loss in total revenue. This same reason also explains why
competitive oligopolists tend to be extremely aware of their rivals’
decisions and strategies (high rival consciousness). An attempt by any firm
to engage in price competition can quickly escalate into a price war, which will
be detrimental to all competitive oligopolists in the industry as all firms will experience lower profit level in LR)
32
define bte
Barriers to entry (BTE) are anything that prevents or impedes the entry of
firms into an industry and thereby impacts the profits that firms can make in
the long run.
33
how to tell if market is competitive/oligopoly
market concentration ratio: ratio of combined market shares to given number of firms
oligopoly: top 5 firms account for more than 60% of total market sales revenue
larger concentration ratio = more oligopolistic
34
implications of characteristics of market structure
1. determines if firm is price taker or price setter
2. market share (Market share refers to the proportion (%) of the firm’s sales revenue
with respect to the industry’s sales revenue.)
3. shape of DD curve (nature of product will determine good's elasticity)
4. profit maximising price and output
5. profits earned in sr and lr
35
define price taker and price setter and state which market structure is which
pt: each firm is so small relative to industry size that they have no power to influence price. will not engage in pricing strategies and can only price at profit-maximising output.
(PC)
ps: can choose what price to charge as each firm has some
degree of ‘market power’
(MPC, oli, mono)
36
lr and sr equilibrium of pc
(refer to diagram in bank)
SR: all possible
LR: normal
supernormal:
- low bte
- more firms enter
-output increases, demand stays the same
- profits are competed away until all firms are just covering tc
- LR equilibrium reached when all firms make normal
subnormal
- low bte
- some firms may shut down and leave
- industry shrinks, output lesser while demand remains the same
- equilibrium price increases as firms exit until each firm in industry makes normal profits
- firms stop exiting
37
lr and sr equilibrium of mpc
(refer to diagram bank)
sr: all 3
LR: Normal
supernormal --> normal
(more firms will join market --> market share for each firm falls as no. of consumers buying from each firm will decrease), DD falls --> normal
subnormal --> normal
LR: some firms will choose to shut down --> more consumers per firm
--> DD increases
- note: shift in curves depend on what is given in question. must be flexible and move curves according to what qns gives
38
lr and sr equilibrium of oli
(refer to diagram bank)
LR: possible to retain supernormal profits in lr
must at least be making normal
39
lr and sr equilibrium of mono
(refer to diagram bank)
LR: retains supernormal profits in LR due to insurmountable btes
unlikely to change pricing and output decision in lr, unlesss bte is lowered then monopoly might change LR equilibrium position
must at least be making normal
40
types of oligopoly
competitive (profit-maximising price tends to be lower) and collusive (cartel)
41
firm's make decisions and engage in ___, _____, and _______ strategies aimed at _____ and/or lowering _____
pricing, cost, product differentiation
raising revenue, lowering unit costs
42
pricing strategies (5)
1. price competition
2. limit pricing
3. predatory pricing
4. 3rd degree price discrimination
5. collusion (oligopoly)
43
non-pricing strategies (5)
1. growth
2. diversification
3. product differentiation/marketing
4. innovation and r&d
5. shut down
44
answering tech for how np strats increase firm's profits
(diagram analysis)
first type: raise revenue = ar and Mr curve shifts RIGHT
second type: lower unit costs - mc and ac curve shift down
third: both
+ some strategies might change ped i.e steepness of ar and Mr
(answer)
1. initially: find area for tr and tc and deduce profit area
2. say how graph changes
3. after: find area for tr and tc and deduce profit area
4. compare profit area, show increase in profits
45
what does firm's decisions impact?
1. efficiency (allocative, productive, dynamic efficiency)
2. equity
3. consumer welfare
(consumer choice, product quality and consumer surplus)
4. other firms (cost, revenue profit)
46
price competition
aim: raise revenue
im:
- price of good is lowered if demand for product is price elastic
- more than proportionate rise in Qd, allowing for higher revenue
- mpc might make occasional price cuts to win customers over from competitors and monopoly wants to earn more revenue
lim:
- other firms may start to reduce prices as well --> price war --> total revenue may fall instead if other firms are able to reduce prices more significantly due to lower costs of productions
impact:
CS: increase
other firms: fall in revenue, fall in profits
AE: improves
equity: improves
47
limit pricing (for dominant firms)
aim: protect market share by deterring entry of new firms (especially used if market is highly contestable)
im:
- reduce price where even normal profits cannot be made (below AC)
- new entrant will not be able to make any profit upon entering market
- dominant firms maintain its market share and power, retain supernormal profits
lim:
- earn less revenue due to lower price set = lower profits, may be earning subnormal profits in SR
48
predatory pricing
aim: drive out existing competitors
im:
- reduce price to below AC, have to tap on retain profits
- consumers switch to firm as it is cheaper, raising demand for its own products
- competitors leave as they may only be making subnormal profits in lr and experience lesser demand
- when they leave, firm captures larger market share, reducing ped value of its products and will the raise prices back to profit-maximising level to earn higher revenue
lim:
- short term subnormal profit requires to tap on retained profits
49
3rd degree price discrimination:
+ conditions
aim: charging of different prices to different customers for different units of the same product when there are no difference in costs , raise revenue and lower cost
conditions
1. seller has some degree of monopoly power
2. market can be effectively segmented to limit ability of customers to resell products to higher priced segments
3. PED differs for different market
determine factor
1. costs do not add up to explain difference
2. products are perfect subs
I'm:
- higher price charged in market where demand is price inelastic
- lower price charged for market where demand is price elastic
- raise revenue: in higher price segment, less than proportionate fall in Qd . in lower priced, more than proportionate rise in Qd
- lower cost: reap IEOS as output increases while costs remain the same -> lower unit cost
lim:
not effective if firms are unable to segment markets properly
50
collusion
refers to situation where firms in a market cooperate to jointly fix prices or output
refer to notes for rest
51
growth
notes
52
diversification
notes
53
product differentiation
notes
54
innovation, r&d
notes
55
shut down
shut down when subnormal profits are made in lr or when AR
56
define consumer and producer surplus
Consumer surplus: difference between maximum amount that a consumer is willing and able to pay for a good and the amount that he actually paid for the good
Producer surplus: difference between the mount that a producer of a good actually receives and the minimum amount that the producer is willing and able to sell the good (measure of producer’s welfare)
Society’s welfare (consumer + producer surplus) is maximised at eq p&q → free market is efficient in allocating resources
57
what is consumer welfare?
consumer surplus + consumer choice + product quality
Consumer choice refers to the range of products made available to
consumers.
58
define allocative, productive, dynamic efficiency
Allocative efficiency is defined as the output level where society’s welfare
is maximised.
Productive efficiency is achieved when a given level of output is
produced at the lowest cost.
Dynamic efficiency refers to the situation when firms invest in technology so that
productivity and product quality will improve over time. This is usually achieved
through innovation, which can come in the form of product innovation and
process innovation. Innovation refers to the efforts put in by a firm to come up
with new, improved of differentiated products.
59
why is market dominance bad?
negative impacts on efficiency and equity
60
Policies to prevent/reduce market dominance
+ aim
AIM: prevent market dominance from occurring/reduce degree of market dominance
1. Legislation: Pro-competition acts (anti trust laws)
2. Lowering BTE
61
When government has to accept the existence of monopoly because it brings other benefits like:
___ for oligopoly as it incentivises them to ____
Firms are able to enjoy ___ → lower prices = ____
dynamic efficiency, innovate
economies of scale (lower unit cost) --> lower prices --> consumer welfare and equity
62
Policies to address the negative impacts of market dominance
1. Regulatory pricing (price controls, mc and ac)
2. Regulatory standards
3. Lump-sum taxes
4. nationalisation
5. public-private-partnership
63
pro-competition acts (anti trust laws)
refer to Google doc
64
lowering bte
refer to Google doc
65
regulatory pricing (MC)
refer to Google doc
66
regulatory pricing (AC)
refer to Google doc
67
regulatory standards
AIM: ensure quality of good which ensures consumer welfare
IM
Impose regulatory standards with penalties to improve consumer welfare by improving quality of good
68
lump-sum taxes
69
nationalisation
70
public-private-partnership
71
define a contestable market
Contestable markets are those that are served by one or few firms, and are kept
operating at competitive price and output levels due to the threat of potential
competition/ potential entry of new firms.
72
characteristics of contestable market
Small number of firms
Market equilibrium that improves ae and pe
Ease of entry and exit of firms: low entry and exit costs
Hit and run competition from potential entrants → incumbent firms unable to raise price
Contestable markets are likely to have competitive prices and low profitability → if it is too profitable, an entrant can easily come in and easily take a big share of profit
Natural monopolies are the least contestable markets because of natural bte such as high eos and asym info
73
difference between contestable market and competitive market
Competitive VS Contestable market
Competitive: many firms existing in market e.g. pc
Contestable market: only a few sellers but threat of new entrants cause sellers to behave competitively
Only oli and mono can be contestable
74
factors influencing contestability
Ease of entry and exit
Sunk costs (zero sunk costs promote contestability) → costs that cannot be recovered when leaving the market, so lower the sunk costs = more willing to enter market
Ability to have access to the same resources as incumbent firms (market may be difficult to enter due to shortage of skilled labour and access to technology, so in contestable market potential entrants must have the same access to resources which
75
implications of contestable market on societal welfare
Implications of contestable market on societal welfare:
Firm might practise limit pricing to deter potential entrant → result in lower prices and higher output → reduces AE, increase cs
Firm might innovate quality of product and improve production process → improve consumer welfare, reduce cop → productive efficiency improved
For essential good: lower price = more equitable
76
criticisms of contestability theory
Criticisms of theory:
Does not consider retaliatory responses by incumbent firm against new entrants e.g. build perceived/artificial barriers like brand loyalty
Unrealistic that new entrants will have same level of expertise as incumbent firm
Time lag for consumers to switch to lower priced products of new entrant firms
