Micro part 7- Economies and Scale, Profit

Question 1

What are economies of scale

Answer 1

1. when the LRAC of production falls as output increases. Only applicable in the l.r.

Question 2

What are internal EOS

Answer 2

1. EoS which arise because of the growth in the scale of production of a firm

Question 3

What are external EOS

Answer 3

1. falling AC of production which result from growth in the size of the industry in which the firm operates. 2.Shown by a movement in the LRAC curve

Question 4

What are Diseconomies of scale

Answer 4

1. when the LRAC of production rises as output increases

Question 5

What are the causes of internal EoS

Answer 5

1. Financial
2. Managerial
3. Purchasing
4. Technical

Question 6

Describe the financial causes of internal EOS

Answer 6

1. banks are more willing to lend loans at lower i.r. to larger firms since they are deemed less risky.
2. This means they have cheaper credit.
3. This means they can invest more cheaply which can increase investment

Question 7

Describe the managerial causes of internal EOS

Answer 7

1. can employ more workers so they are able to specialise and divide their labour.
2. This can increase productivity because [specialisation].
3. They can also hire specialised managers for different sections of the business to maintain control over these separate parts, increases efficiency.
4. Also number of managers doesn’t depend directly on the scale of production so this reduces the management cost per unit

Question 8

Describe the purchasing causes of internal EOS

Answer 8

1. large firms can afford to buy in bulk so can negotiate cheaper prices than smaller firms.
2. This means their factor inputs have lower prices

Question 9

What are the causes of external EOS

Answer 9

1. Better infrastructure which can reduce transport costs
2. When the pool of workers that work in an industry go through increased training e.g. through gov. schemes then it reduces training costs of workers.
3. Alternatively can poach workers from other firm

Question 10

What are the causes of internal diseconomies of scale

Answer 10

1. When the firm grows so large it is impossible to coordinate all areas of the business.
2. This can lead to different objectives from different sections arising, or increase waste since can’t easily coordinate resource allocation.
3. This can lead to x-inefficiency which increase costs
4. Communication becomes more difficult which can cause workers to feel more alienated.
5. This can reduce morale, reducing productivity and increasing costs
6. Geographical reasons like as a firm increases in size then needs to distribute goods over larger distances so an increase in costs is inevitable

Question 11

How can you combat the causes of internal diseconomies of scale

Answer 11

1. centralise management with a small team overseeing all activities to ensure objectives across the firm are kept the same and reduce waste
2. decentralise with smaller subsidiary companies which allows increased monitoring

Question 12

What are the Causes of external diseconomies of scale

Answer 12

1. As an industry becomes bigger then there is increased competition for resources.
2. This increases the price for them which rises costs for factor inputs for all firms in that industry, assuming supply has not increased enough to meet the demand (excess demand)
3. If the gov. imposes a tax the will increase LRAC
   Principal agent problem [divorce of ownership from control]

Question 13

What is accounting profit

Answer 13

1. the total monetary revenue mine total costs.

2. Higher than economic profit

Question 14

What is economic profit

Answer 14

1. considers the opp. cost of production in addition to monetary costs.
2. Measured by the benefit that could have been gained if the resources employed in the production process had been used in their next most profitable use

Question 15

What is normal profit

Answer 15

1. occurs when TR = TC.
2. This means the extra revenue left after covering a firm’s money costs is equal to the opp. cost of the FoP that aren’t paid for.
3. If extra revenue is less then it means the firm would have been better off putting the FoP to a different use.
4. It is the minimum profit to keep resources in their current use in l.r.

Question 16

What is abnormal profit

Answer 16

1. occurs when TR > TC.
2. This means the revenue generated from using the FoP in this way is greater than could have been generated in any other way.
3. Creates an incentive for firms to join the market

Question 17

What is a loss

Answer 17

1. A loss is when a firm fails to cover their TC

Question 18

What profit do firms need to keep operating in the l.r.

Answer 18

1. Firms need to make normal profit to keep operating in the l.r.
2. If it can’t then will close because its revenue is not covering all the costs.

Question 19

What does a firm require to continuing operating in the s.r. and what causes it to close immediately

Answer 19

1. In the s.r. a loss-making firm has fixed costs to pay no matter the revenue so may continue to operate in the s.r.
2. if TR > TVC or AR > AVC then continue to operate in the s.r. since the extra revenue can contribute towards paying fixed costs
3. if TR < TVC then will close immediately

Question 20

When is profit maximised

Answer 20

1. Profit is maximised when MC = MR

Question 21

What happens if MC > MR

Answer 21

1. Decrease output since it’s costing firms more to produce the last unit of output than it receives in revenue

Question 22

What happens if MC < MR

Answer 22

1. increase output because the revenue gained by increasing output is greater than the cost of producing it

Question 23

What is the role of profit in market economy

Answer 23

1. Incentive – a reason to invest and set up businesses
2. Signal – signal where consumer demands are, so helps allocate resources, not always in best interest of society due to imperfect information
3. Used to fund investment and allows government to collect tax revenues