Micro L4 - 7 Flashcards
Constant returns to scale:
Output increases in the same proportion as all inputs
Increasing returns to scale:
Output increases by a lather proportion than all inputs
Decreasing returns to scale:
Output increases by a smaller proportion than all inputs
What does the long-run average total costs represent?
Lowest possible average cost
What is the relationship between SRATC and LRATC?
LRATC is a tangent to each of short-run cost curves
Economies of scale:
Decreases in long-run average costs of production as firm increases all its output
What do falling average costs mean for returns to scale?
There will be increasing returns to scale
Internal economies of scale (really fun mums try making pies):
1) Risk-bearing
2) Financial
3) Marketing
4) Technical
5) Managerial
6) Purchasing
How do technical economies of scale make large-scale production more efficient?
- The larger the object, the lower the AC of storage
- Some capital equipment is designed for large scale production
- High overhead expenditures that may only be viable when a firm is large enough
- Existing capital used more efficiently
- Specialist machinery boosts productivity
- Employ more workers as firm gets large to specialise
How do managerial economies of scale make large-scale production more efficient (+ evaluation)?
- Can employ specialist managers, which leads to better decision making abilities + increased productivity
- May experience diseconomies as AC may rise as firm is so large that management becomes difficult
How do marketing economies of scale make large-scale production more efficient?
- Advertising is usually a fixed cost so it is spread over more units (bulk-buy) , meaning cost per unit is lower
- Benefit from brand awareness of well-known brand
How do financial economies of scale make large-scale production more efficient?
Large firms may have the advantages of a strong rep such as negotiation of lower interest rates as banks think they are low risk
How do purchasing economies of scale make large-scale production more efficient?
- Good deals can be negotiated when inputs are purchased in relatively large volumes (bulk-buying)
- Costs can be spread across wider range of output
How do risk-bearing economies of scale make large-scale production more efficient?
- Can diversify leading to more predictable demand
- Can afford to take risks spread over more units
External economies of scale (involved in industry but outside firm):
1) Better transport infrastructure –> cheaper for transportation of supply
2) Component supplies may move closer –> cheaper for transportation of supply
3) R & D firms move closer –> improve tech, reducing costs
Diseconomies of scale:
Increases in long-run average costs of production as firm increases its output
MES:
- Minimum efficient scale
- Lowest level of output required to exploit full economies of scale
What part of the LRAC curve is each economy of scale? responsible for?
- Downward sloping –> Increasing returns (economies of scale)
- Horizontal section
- Upward sloping –> Decreasing returns (diseconomies of scale)
What are the variations of LRAC curve?
- Bucket shape (regular)
- Positive quadratic (very rare) –> immediate switch from increasing to decreasing returns to scale
- Decreasing concave up (natural monopoly) –> much higher output required for MES
Why do natural monopolies require much higher outputs for MES?
They have very high fixed costs
Reasons for diseconomies of scale (3Cs and a M):
All lead to growing inefficiencies:
- Control –> may decrease due to more workers
- Coordination and monitoring difficulties –> difficult for departments to work together
- Communication difficulties –> harder to communicate
- Poor worker motivation –> each worker feels their value is low
Profit formula:
profit ( π ) = total revenue - total costs
What is the difference between accounting and economic profit?
- Economic profit –> Considers both implicit and explicit costs
- Accounting profit –> Only explicit costs
Normal profit:
Minimum reward necessary to keep factors of production in their present use
What are the conditions for normal profit?
- Total revenue = Total costs
- Intersection of TR and TC
- Zero economic profit
What are the conditions for supernormal profit?
- Total revenue > Total costs
- Point where TC is furthest from TR
- Positive economic profit
What are the conditions for subnormal profit?
- Total revenue < Total costs
- Negative economic profit (loss)
When does shutdown occur for a firm?
When the firm is not covering average variable costs and therefore does not make a contribution to the fixed costs
What is the long-run shutdown point on a graph?
Where price < average cost
What is the short-run shutdown point on a graph?
When price < average variable cost
Shutdown or not formula:
1) Calculate TR (P x Q)
2) Calculate TVC (AVC x Q)
3) Calculate TC (TFC + TVC)
4) If TR - TC < TFC, stay open
OR
1) Selling price - Variable cost per unit
Objectives of firms:
1) Profit maximisation
2) Satisficing (H Simon)
3) Revenue maximisation (W Baumol)
4) Managerial utility maximisation –> cut into profits for satisfaction of employees
5) Corporate Social Responsibility
6) Survival –> merely existing in hyper-competitive market (short-term)
7) Public sector organisation
Why is profit maximisation assumed to be the main objective of firms?
1) Reinvestment –> profit into new capital, R & D
2) Dividends for shareholders
3) Lower costs + lower consumer prices
4) Reward for entrepreneurship
At what point is profit maximised on a MC and MR graph?
When MC = MR
Reasons for not aiming for profit maximisation:
- Unaware of values for MC and MR
- Under greater scrutiny
- Key stakeholders harmed
- Other objectives may be more appropriate
Profit satisficing (satisfy + sacrifice):
Sacrificing profit to satisfy as many key stakeholders as possible
Stakeholder meaning and examples:
- Anybody who has an interest in the performance of business
Examples: - Shareholders
- Managers
- Consumers
- Workers/TUs
- Gov
- Environmental grps
Out of key stakeholders, who is likely to be unhappy w/ profit maximisation and why?
- Consumers could suffer if excess prices are charged
- Workers/TUs due to low wages from cost-cutting
- Gov if excess prices charged for consumers + wages are low
- Environmental grps if environment is negatively affected due to cost-cutting
Revenue maximisation and who proposed the idea:
- When MR = 0
- William Baumol
Reasons for aiming for revenue maximisation:
1) Economies of scale –> revenue quantity is greater than profit max quantity
2) Predatory pricing
3) Principal- agent problem –> managers may use revenue max as leverage for greater perks in job from shareholders
Predatory pricing
Undercutting rival and sacrificing profit to drive out competitors
Sales maximisation:
- Business wants to become as large as possible without making a loss
- When AC = AR
Reasons for aiming for sales maximisation:
1) Economies of scale –> sales quantity is greater than profit + revenue max quantity
2) Limit pricing –> removes incentive of new firms entering market
3) Principal- agent problem –> managers may use sales max as leverage for greater perks in job from shareholders
4) Flood market –> Greater awareness from consumers
Aim of public sector organisation:
- P=MC (D = S)
- Maximise social welfare
Corporate social responsibility:
Acting ethically to avoid revenues and profits decline due to consumers not agreeing w/ practices
Components of economic efficiency:
1) Allocative efficiency
2) Productive efficiency
3) X efficiency
4) Dynamic efficiency
Productive efficiency:
Minimum AC at which output can be produced
Allocative efficiency (welfare maximisation):
Whether an economy allocates its resources in such a way to produce a balance of goods and services that meet consumer preferences
How can allocative efficiency be measured?
S = D, MSB = MSC, A.R. = MC
X efficiency:
- Minimising waste
- X inefficiency: When a firm operates above its AC curve
- X efficiency: Production is on AC curve
Why do X inefficiencies occur?
1) Monopoly –> lacks competitive drive, leads to complacency
2) Public sector firm –> lack profit drive as they aim for social welfare, leads to inefficiencies
Dynamic efficiency:
- Reinvestment of long-run supernormal profit
- Occurs over time
Static efficiency:
- Allocative, productive and X efficiency
- Efficiencies that occur at one specific production point
