Micro part 6- Revenue/sales maximisation, Profits and Costs

Question 1

When does Revenue maximisation occur

Answer 1

1. occurs when MR = 0 meaning each extra unit sold generates no extra revenue

Question 2

When does sales maximisation occur

Answer 2

1 occurs when AC = MR

Question 3

What can sales maximisation result in

Answer 3

1. Can put other firms out of business.
2. This occurs because sales maximisation allows large firms to push rivals out of business by increasing their market share.
3. By increasing their scale of production by increasing their market share they can benefit from economies of scale.
4. This can allow them to reduce costs and prices so that smaller firms can’t compete and go out of business.
5. Consumers can benefit from lower prices but may suffer from less choice- less product quality

Question 4

What is growth maximisation

Answer 4

1. Can be either sales, revenue, assets or market share
2. Aim to increase the size of the firm
3. Allows them to take advantage of EoS
4. Aim to maximise l.r. profits

Question 5

What is utility maximisation

Answer 5

1. Maximisation for consumers is when MU = 0, maximum satisfaction received from consumption
2. Maximisation for firms is to generate highest profits
3. Some economic models assume that all stakeholders have some power to influence behaviour of a firm
4. The behaviour of the firm is therefore determined by the relative power of each of the stakeholders

Question 6

What is Profit satisficing

Answer 6

1. Satisficing – firms doing just enough to satisfy stakeholders, as opposed to maximising due to divorce of ownership from control
2. May pursue other objectives but only up to a point where a minimum profit level (imposed by shareholders) is reached
3. Arises when different stakeholders within a firm have different objectives
4. This creates a principal agent problem but can be overcome by things like profit related rewards

Question 7

What affect can governments imposing other objectives like quality of good requirements or environmental standards have

Answer 7

1. This results in price being set where P = MC which achieves allocative efficiency (assuming no externalities)
2. This can benefit firms by improving quality but won’t benefit firm in the l.r. assuming they are profit maximisers, but is acceptable if they are ‘not for profit’

Question 8

What happens when the industry is a natural monopoly

Answer 8

1. When the industry is a natural monopoly then will always be loss-making since MC is always below AC.
2. If the natural monopoly wants to remain in business then requires subsidies

Question 9

What is corporate social responsibility

Answer 9

1. some say that it is simply there to improve public image.
2. When are profit maximisers then unlikely to sacrifice profit for things like environmental standards.
3. Can hide this due to asymmetric information
4. can increase profitability of firms as things like recycling can reduce waste and allow the firm to be technically efficient

Question 10

Which factors influence the choice of objectives

Answer 10

1. The main reason is the type of market structure
2. Aim of owners e.g. benefit society or increase social welfare
3. An uncompetitive market structure the relative power of shareholders vs managers or competition vs collusion based on the contestability
4. In the real world can be hard to identify marginal cost/revenue making it hard to profit maxims

Question 11

How can market structure affect the choice of objectives

Answer 11

1. since if in perfect competition then only choice to profit maximise to stay in the industry into the long run.
2. This can be influenced by things like barriers to entry

Question 12

What is short run costs

Answer 12

1. Short run – where are least one FoP is fixed meaning there are fixed costs (do not vary with output)

Question 13

What is long run costs

Answer 13

2. Long run – where all factor inputs can change meaning all costs are variable (vary with output)

Question 14

What is the Law of diminishing returns

Answer 14

1. if one variable FoP is increased while at least 1 factor is fixed then the marginal returns from the variable factor will decrease.
2. As more units of a variable unit are utilised the change in total output will at first rise and then fall

Question 15

When does the Law of diminishing returns apply

Answer 15

1. only in the s.r

Question 16

What is a marginal product

Answer 16

1. Marginal product – the additional output produced by adding one more unit of a factor input, keeping the others fixed (MP = MR)

Question 17

What is an average product

Answer 17

1. Average product – the output produced per unit of factor input (productivity). Improve it through training or tech.
2. This reduces a firm’s CoP

Question 18

What happens to MP as you add more of a FOP

Answer 18

1. Initially as you add more of a FoP the MP will increase, each unit of input will add more output than the one before it.
2. Occurs because more specialisation is possible with more of a particular factor
3. Eventually if you keep adding units of one factor then the other fixed factors will limit the additional output you get, so MP falls
4. This is the point of diminishing returns where MP decreases as input increases

Question 19

What happens to MR as MC rises

Answer 19

1. As MC rises then MR will fall because if you’re getting less unit of output from each unit of input then costs per unit of that output will increase

Question 20

What to MP as labour levels increase

Answer 20

1. LoDMR states that as the level of labour increases then MP will begin to diminish
2. as level of factor input increases then eventually AP will fall too. MP meets the AP curve at its maximum
3. if you keep adding more input then total product will falls since workers may be getting in each other’s way

Question 21

What is the relationship between SRAC and LRAC

Answer 21

1. SRAC is u-shaped because of the LoDMR meaning that as a firm increases output in the s.r. by increasing a variable factor then it’ll move along the SRAC curve, where at first AC decreases without but then falls
2. In the l.r. all FoP are variable, so as it changes a FoP then it’ll move onto a new SRAC curve which is along a LRAC curve
3. The SRAC curve can be on the LRAC curve but not below since to operate on its LRAC curve at a particular level of output then it must be using the most appropriate mix of FoP
4. LRAC curve can be shifted because in l.r. all FoP are variable- is U-shaped due to facing internal EoS and then internal DEoS

Question 22

Describe short run cost curves- TFC, TC, TVC and FC

Answer 22

1. TFC is vertical because will not change no matter the output
2. TC and TVC are parallel because the distance between the two is the constant TFC
3. The inflections show where diminishing returns set in
4. FC falls as output increases because FC represent an ever-decreasing proportion of TC

Question 23

Describe short run cost curves- AC, AVC, AFC and MC.

Answer 23

1. AC and AVC falls at first and then rise because diminishing average returns set in
2. Vertical distance between AC and AVC curves is the value of AFC
3. MC falls at first then rises as diminishing marginal returns set in
4. All u-shaped due to law of diminishing marginal/average returns

Question 24

Describe MC relationship to AVC and ATC

Answer 24

1. MC cuts the AVC and ATC because if AC is falling then the extra cost of an additional output (MC) must be less than the AC.
2. If AC is rising then it must be true that marginal cost has risen by more than that.
3. Therefore when AV is neither rising nor falling then it must equal MC.
4. if AC is constant then it will equal MC
5. If MC > AC then AC is increasing
6. If MC < AC then AC is decreasing

Question 25

What is returns to scale

Answer 25

1. Returns to scale – describes the effect on output of increasing all factor inputs by same proportion

Question 26

What does a firm experience as it expands

Answer 26

1. Increasing returns to scale (an increase in inputs leads to a more than proportional increase in output),
2. Constant returns to scale (increase in inputs has proportional increase in output)
3. Decreasing returns to scale (increase in input leads to a less than proportional increase in output)

Question 27

What is MES

Answer 27

1. the lowest level of output at which the minimum possible AC can be achieved.
2. This is the optimum level of output since costs are lowest and EoS are being fully utilised.
3. Important as can determine the market structure (relative to demand)
4. e.g. if it is large then firms tend to be large because of the advantages of EoS and show optimum number of firms in industry

Question 28

What is total revenue

Answer 28

1. the total amount of money received from a firm’s sales in a period of time (TR) = Quantity x Price

Question 29

What is average revenue

Answer 29

1. the revenue per unit old (AR)

2. = Total Revenue/Quantity

Question 30

What is marginal revenue

Answer 30

1. The extra revenue from selling an extra unit of output (MR)
2. =Change in total revenue/Quantity

Question 31

When is TR maximised

Answer 31

1. TR maximised when MR = 0 or PED = -1

Question 32

Describe MR, TR and AR curve

Answer 32

1. MR curve is twice as steep as TR curve
2. AR curve is the same as demand curve because AR is the price of a good
3. A price taker has a perfectly elastic demand and therefore AR and MR curve.
4. The TR is a line since TR increases proportionally with sales