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Microeconomics OMAR > micro 26-33 -- theory of the firm > Flashcards

micro 26-33 -- theory of the firm Flashcards

1
Q

define short run?

A

at least 1 factor of production is fixed.

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2
Q

define long run?

A

when all factors of production are variable.

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3
Q

what is the law of diminishing returns?

A

the theory that states that as we add variable factors of production to a fixed factor, marginal output will go up then go down because they get in each others way.

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4
Q

define marginal output/product?

A

the change in total output from employing an extra unit of labour

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5
Q

define average output/product?

A

output per worker per unit of capital

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6
Q

how does the law of diminishing returns occur?

A

as we add successive units of labour, marginal output increases due to specialisation, then is falls because of capacity constraints

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7
Q

How do the MP and AP curves look?

A

MP has to go through AP at its highest point.

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8
Q

how does the long run average costs curve look like?

A
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9
Q

why is the LRAC curve shaped the way it is?

A

in the long run, a firm can change its its FOP’s by buying more land or capital. IF we assume that Q1 shows initial output, its costs will be shown by C1. As the firm buys more capital, it will move into a new short term, allowing it to increase its output and reduce average costs. This is because its fixed costs can be spread over a large number of units.

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10
Q

what is internal growth?

(organic)

A

when a business grows/expands by generating more sales.

  • new range of products.
  • reinvest money.
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11
Q

what are 3 limitations of internal growth?

A

limited finance.
time lag.
market saturation.

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12
Q

define external growth?

(inorganic)

A

business expands through mergers and takeovers.

  • merger is a partnership.
  • takeover is buying the firm.
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13
Q

define horizontal integration?

A

when a company buys another company in the same stage of production.

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14
Q

define backward vertical integration??

A

a firm buys another company in an earlier stage of production (supplier)

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15
Q

define forward vertical integration?

A

a firm buys a company with a later stage of production (retailer)

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16
Q

define conglomerate integration?

A

when a firm diversifies by taking over a firm in a different industry.

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17
Q

pros and cons of horizontal integration?

A

PROS:
- lower prices for consumers due to EOS as AC falls. (might not pass on).
- more profit for firms due to selling more outputs (extent of price fall).
- Reduces competition.
CONS:
- might create a monopoly leading to higher prices.
- suppliers get less money money due to monopsony power.

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18
Q

pros and cons of backward vertical integration?

A

PROS:
- greater control over supply.
- EOS benefit.
- More profit.
(might not pass on costs)
CONS:
- less choice for consumers.
- monopoly power.
(might lower prices to sell more units)

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19
Q

pros and cons of conglomerate integration?

A

PROS:
- Less risk as they are in 2 different industries.
CONS:
- lack of experience in new industry might lead to business failure.

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20
Q

pros of growing?

A
  • increase profits.
  • gain EOS.
  • Efficiency savings.
  • greater control over supply chain.
  • Reduces risk for firms.
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21
Q

who regulates competition in the UK?

A

CMA - competition and markets authority.

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22
Q

cons of growing?

A
  • Increase arguments/incompatibility.
  • requires finance.
  • Less choice for consumers.
  • Possible diseconomies of scale.
  • Possible job losses.
  • Different industries require different skills.
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23
Q

define demerger?

A

a form of restructuring in which a company sells off its business operations or when they split into 2 firms.

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24
Q

why do companies demerge?

A
  • potential increase in costs - selling off loss making subsidiaries.
  • might be no economies of scale.
  • sell unprofitable divisions.
  • avoid attention from competition authorities.
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25
Q

what is the shutdown point?

A

when the price is below average variable cost.

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26
Q

why might a firm keep producing even if average revenue is less than average total costs?

A

Overtime, thye use the unit profit to pay off the fixed costs.

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27
Q

what is the short run shutdown point?

A

below P1 where you are not covering average variable costs.

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28
Q

what happens when a firm is operating below P1, not being able to cover variable costs?

A

they have to leave the industry.

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29
Q

what is the long run shutdown point?

A

It is shown between P1 and P2. If a firm has a price between these, they are still covering variable costs and should continue operating as unit profit will pay off the fixed costs overtime.

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30
Q

why might firm continue to produce even when they are below the SR shutdown point?

A
  • confident that it might pick up in the future.
  • high barriers to exit.
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31
Q

How is the total costs curves drawn?

A

PART A: initial increase in costs.
PART B: division of labour.
PART C: diminishing returns.

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32
Q

define economies of scale?

A

A reduction in long run average costs due to an increase in the scale of production.

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33
Q

define internal economies of scale?

A

A reduction in LRAC that occur within a firm as a result of growth.

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34
Q

what are the 6 types of internal economies of scale?

A
  1. purchasing EOS (bulk buying)
  2. technical EOS.
  3. managerial EOS.
  4. Marketing EOS.
  5. Financial EOS.
  6. Risk bearing EOS.
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35
Q

what is purchasing economies of scale?

A

Buy large quantity.
Monopolies get discounts.

Eg: larger supermarkets being cheaper than small questions.

36
Q

what is technical economies of scale?

A

more efficient if capital is used to full capacity and those fixed costs are spread out over a large number units.
High fixed costs.
Less employees needed.
Eg: large car factory, large manufacturing plant.

37
Q

what is managerial economies of scale?

A

specialist staff being more efficient as they have expertise.
Big firms can afford their high wages.
Eg: MNC’s

38
Q

what is marketing economies of scale?

A

ability of big firms to advertise on bigger mediums like TV. Marketing costs are spread over a large number of output.

39
Q

what is financial economies of scale?

A

Ability of big firms to raise money.
1. borrow money at lower interest rates because of better credibility.
2. issue corporate bonds.
3. issue shares to the public.

40
Q

what is risk bearing economies of scale?

A

diversification - new products in new markets.
Eg: uber and uber eats.
amazon and prime videos.

41
Q

define external economies of scale?

A

a fall in the LRAC curve caused by the growth of the industry.

42
Q

what are the 4 reasons/examples of external economies of scale?

A
  1. New production techniques - lowers AC.
  2. Access to skilled labour - new graduates are skilled.
  3. Better infrastructure - transport.
  4. Ancillary EOS - related industries emerging such as supplier of the firm.
43
Q

define diseconomies of scale?

A

an increase in the LRAC due to an increase in the scale of production.

44
Q

Why might diseconomies of scale occur?

A
  1. Poor communication - As a company gets bigger and adds more layers, the decision making and communication becomes slower.
  2. Lack of motivation - You feel less significant in a bigger firm, reducing productivity.
45
Q

define external diseconomies of scale?

A

an increase in the long run average costs curve caused by the fall in growth of the industry.

46
Q

define minimum efficient scale?

A

The lowest point of the average costs curve - point of where all costs are being minimised.

47
Q

Draw EOS, DEOS and minimum efficient scale on a diagram.

A
48
Q

What firms may not experience DEOS?

A

Natural monopolies such as Thames water and BT.

49
Q

why is the Average revenue curve downward sloping?

A

As price falls, demand increases.

(monopoly firm has to reduce price to sell more units)

50
Q

define marginal revenue?

A

The extra money received from selling the extra unit of good.

51
Q

what is the shape of the MR curve and explain the reason.

A

downward sloping - 2 times as steep as the AR curve. This is because everytime AR falls, MR falls by 2. (mathematical proof)

52
Q

how does the price elasticity change along the demand curve?

A
53
Q

what can be said about total revenue as output increases, when demand is price elastic and when demand is inelastic.

A

When elastic, total revenue increases.
When inelastic, total revenue falls.

54
Q

define barriers to entry?

A

obstacles preventing firm from entering a market.

55
Q

explain high start up costs as a barrier to entry?

A

IF expensive capital is needed, small firms can’t afford to operate. The risk is too high and owners will be concerned.

56
Q

explain EOS as a barrier to entry?

A

New entrants producing on a smaller scale will have high average costs and wont be able to compete with big firms.

57
Q

explain brand names as a barrier to entry?

A

high brand loyalty makes consumers unwilling to try new brands. Wont buy from competitors even if price is lower.

58
Q

explain ownership of raw materials as a barrier to entry?

A

if a firm controls supply of a raw material/input that you need, it will be difficult for you to operate and compete.

59
Q

explain awareness of barriers as a barrier to entry?

A

Firms will be discouraged from entering the market if they know there are costs involved in leaving it.

60
Q

explain limit pricing as a barrier to entry?

A

existing firms may lower price to just above AC to make it difficult for new entrants to cover their costs. This is because big firms benefit from EOS and small firms dont.

61
Q

explain predatory pricing as a barrier to entry?

A

Incumbent firms (existing) set a price below AVC, but dont shutdown, driving other business out of the market.

62
Q

define barriers to exit?

A

obstacles to prevent firms from leaving the market

63
Q

what are the 2 barriers to exit?

A
  1. Sunk costs - Costs which are not recoverable such as assets that cant be recovered by selling them.
  2. Contracts - Legally obligated to supply the product.
64
Q

how is unit profit calculated?

A

AR - AC
(profit/quantity)

65
Q

What 3 scenarios arise from running an enterprise?
(Profits and loss)

A
  1. Supernormal profits (AR>AC).
  2. Normal profits (AR=AC).
  3. Loss (AC>AR).
66
Q

what do economists include in the firms profits?

A

Opportunity costs.

67
Q

Define normal profits?

A

Minimum amount of profit needed to stay competitive in the market.

68
Q

define supernormal profits?

A

Average revenue is grater than average costs.

69
Q

what roles does profit play in an economy?

A
  1. Signalling to producers to increase production.
  2. Allows investment.
  3. Reward for enterprise.
  4. Pay dividends.
70
Q

what is the profit maximising condition?

A

MR=MC

71
Q

what happens to profit maximisation when MR exceeds MC?

A

The firm is not maximising level of output, the firm needs to increase production because MR for each unit exceeds MC.

72
Q

what happens to profit maximisation when MC exceeds MR?

A

The firm needs to decrease production, because the MC for each unit is greater than MR.

73
Q

how can profit maximisation levels be shown on a diagram?

A
74
Q

which firms might not engage in profit maximisation?

A

Non profits.
govt organisation.
sole traders - survival?

75
Q

define of divorce ownership and control?

A

owners and managers are different people.

76
Q

define the principal agent problem?

A

The objectives of managers and owners are different

77
Q

do all PLC’s maximise profit?

A

YES:
- to pay shareholders dividends.
NO:
- ethical and environmental objectives –> CSR.

78
Q

explain the alternative objective of sales revenue maximisation?

A

managerial perks are associated with revenue: healthcare, cars, bonuses.
sales revenue maximisation is when MR=0.
Some firms might start of with lower prices to maximise revue because demand will be higher.

Criticism:
- Maximising revenue is also maximising profit.
- it lowers costs at the same time if you maximise profit instead.

79
Q

explain the alternative objective of sale volume maximisation?

A

This is when AC=AR.
producing less would mean they are missing out on profit because AR>AC.

Criticism:
- Not applicable for every industry (luxury brands)
- long term goals have to be profit maximisation especially it its a PLC.

80
Q

why might profit maximisation be the main goal in the long run despite other objectives?

A
  1. If you survive in the SR, you can maximise profits in LR.
  2. sales/volume maximisation leads to profit maximisation assuming the costs stay the same.
  3. sales/volume maximisation leads to increased market share which leads to EOS in the Long run.
81
Q

define productive efficiency?

A

When average costs are minimised. Bottom point of the AC curve. MC=AC.

82
Q

define allocative efficiency?

A

when price is equal to marginal costs. AR=MC

83
Q

why is this the condition for allocative efficiency?

A

This is the point where supply meets demand and equilibrium stands. This is also where the optimum level of output is achieved, as the value consumers place on the product is equal to the cost of the last unit of the good.

84
Q

define dynamic efficiency?

A

efficiency in terms of developing new products and improving the production process.

85
Q

what might stop many firms being incentivised to be dynamically efficient?

A
  • may not have enough profits to reinvest after they pay dividends.
  • limited funds.
  • limited technology.
  • regulations.
86
Q

define X-efficiency?

A

when actual cost is above potential cost.

87
Q

why does X-inefficiency occur?

A
  • Unnecessary workers.
  • Lack of supervision.
  • Not finding cheapest suppliers.
  • organisational slack.
  • lack of competition.

Microeconomics OMAR (24 decks)

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