Micro Theme 3 Flashcards
What is total revenue?
The revenue received from the sale of a given level of output
P * Q
What is average revenue?
- Average receipt per unit, the price each unit is sold for
- AR curve is the firms demand curve
- AR = Price = Demand
- Total revenue / quantity
What is marginal revenue
- the extra revenue a firm earns from the sale of one extra unit
Change in revenue / change in quantity
What does it mean when MR = 0?
Total revenue is maximised
Where does MR = 0 occur?
- directly below the midpoint of AR curve
- middle of the demand curve
- PED = 1
What does it mean when a firm is a price taker?
- a market participant that is not able to dictate the prices in a market
What does it mean when a firm is a price maker?
- firm has some degree of market power to set its prices within the market
- found in any imperfectly competitive market structure
What does the AR curve look like in price-takers?
- Horizontal
- price received for the good is constant because the good is perfectly elastic
Why is the AR curve downward sloping?
- price per unit is reduced as extra units are sold
- law of diminishing marginal utility
What is total cost?
- how much it costs to produce a given level of output
- total costs = total variable costs + total fixed costs
What are total fixed costs?
- occur in the short run
- fixed costs do not vary with output
- indirect cost
What are total variable costs
- Occur in the long run
- variable costs change with output
- all factor inputs can change
- direct cost
How to calculate ATC?
Total costs/quantity produced
ATC = AVC+AFC
How to calculate average fixed/variable costs
Total fixed/variable costs / quantity
What is marginal cost?
- How much it costs to produce one extra unit of output
- Change in TC/Change in Q
What is the effect on MC and AC when a firms total variable costs increase?
- both curves shift upwards
What is the effect on MC and AC when a firms total fixed costs increase?
- No effect on MC
- only AC shifts upwards
What is the law of diminishing marginal productivity?
- adding more units of a variable input to a fixed input increases output at first
- after a certain number of inputs are added marginal increase of output becomes constant
- then marginal increase in output starts to fall
Marginal costs rise with…
Increasing diminishing returns
Describe the trend in the cost curves as output increases
- MC, ATC and AVC rise with diminishing returns
- AFC falls with increasing output
What is the lowest point on the cost curves (apart from AFC) representative of?
The point where diminishing marginal productivity sets in
Why does the average variable cost curves tend towards the average total cost curve as output increases?
- because average fixed costs becomes increasingly small in comparison
What is the LRAC curve?
Why does the MC curve slope upwards
Each additional until requires more effort to produce than the previous one
Why does marginal cost slope down at first as output is increased
Specialisation is more powerful than Diminishing Marginal Returns
- workers can specialise
- competition encourages motivation
- teamwork and collaboration
As a firm expands at first they are likely to experience…
- The benefits of internal economies fo scale
- LRAC is likely to fall
All points on the LRAC show…
minimum attainable ATC of production for any given output - assuming the firm is able to adjust its scale accordingly
what is the most important factor affecting the AC, AVC and MC in the short run?
Increasing and diminishing returns to a variable factor
what is the LRAC cost curve most affected by
economies and diseconomies of scale
What do we call it when an increase in the input of all FoPs leads to a larger increase in output
Increasing returns to scale
- the firm has experienced economies of scale, resulting from a rise of productivity
What is the opposite of increasing returns to scale
decreasing returns to scale
What is the MES?
Minimum efficient scale
- produces the lowest average cost of production in the long run
- the lowest level of output that a firm can produce and still be cost competitive
What is risk bearing?
- when a firm becomes larger they can expand their production range and spread the cost of uncertainty
- if one part is not successful they have other back up production channels
what is financial ES
banks are willing to lend loans more cheaply to larger firms as they are deemed less risky - they can take advantage of cheaper credit
what is managerial ES
Larger firms are more able to specialise and divide their labour, they can employ specialist managers and supervisors, which lowers AC
what is technological ES
Larger firms can afford to invest in more advanced and productive machinery and capital, lowers AC
what is marketing IES
Larger firms can divide their marketing budgets across larger outputs so AC of advertising per unit is lowering
Why are short run cost curves U-shaped
Initially, as production increases, average costs decrease due to spreading fixed costs and increasing efficiency
After, diminishing margins returns cause cost to increase and labour becomes less efficient
why is the LRAC curve u shaped
economies of scale
What is purchasing IES
larger firms can bulk buy which means lower costs
what is the acronym for internal economies of scale
Really Fun Mums Try Making Pies
what are network economies of scale
gained from the expansion of e-commerce
When do external economies of scale occur?
- when an industry gets larger
- more development or research lowering costs
what are Internal diseconomies of scale?
-when output passes a certain point and average costs start to increase per extra unit of output produced
what are technical economies of scale
an increase in productivity due to a change in the process of production when the scale of a firms operations increase
what are four technical economies of scale
Specialistion
- specialised machinery
Indivisibilities
- extremely productive machinery is often large and exspensive and only available in large sizes, only when firms rate large can they use this machinery otherwise they will be operating with excess capacity
Linkage of processes
- to satisfy each machines capacity
Economies of increased dimension
- increasing dimensions of storage or transport vessels leads to a larger increase in capacity
Give three examples of internal diseconomies of scale
Bureaucracy:
- it becomes harder to monitor how productive the workforce is as the firm + managerial cost increases
Communication:
- it is harder and complicated to communicate to every worker when the firm is larger (prod decrease)
Alienation:
- workers may feel excluded as firms grow leading to a fall in productivity and increase in LRAC
What does it mean for demand when marginal revenue is positive?
Elastic
what does it mean when MR is negative/
Demand is inelastic
how does demand change as MR decreases
elasticity changes from elastic to unitary to inelastic
what does it mean when MR = 0 for total revenue
total revenue is maximised
how does total revenue change as mr changes
positive mr = tr increases
Negative mr = tr decreases
How does external economies of scale affect LRAC?
shifts the entire curve downwards
What is profit
TP = TR - TC
What is the condition for profit maximisation?
Profit: The difference between TR and TC
Profit Max: MC = MR
What is normal profit?
- Minimum reward required to keep entrepreneurs supplying their enterprise in the long run
- covers the opportunity cost of investing funds into the firm and not somewhere else
- TR = TC
What are supernormal profits?
- profit above normal profit
- exceeds value of opportunity cost of investing funds into the firm
TR>TC
What are losses?
a firm makes a loss when they fail to cover their total costs
TR<TC
AR<ATC
Firms continue to produce in hte short run if…
variable costs are covered
Are fixed costs considered when a decision to shut down is being made?
no, they need to be paid anyways. Only variable costs are considered
what is the short run shut down point
AR = AVC
Lowest point on the AVC curve
Efficiency can be used to…
judge how well the market allocates resources and the relationship between scarce inputs and outputs
What is the point on a CR graph where Cost Minimum
AC = MC
where is profit max on a CR graph
MC = MR
where is revenue max on a CR graph
MR = 0
where is sales max?
AC = AR
what is allocative efficiency?
- P = MC
- When resources are used to produce goods and services which consumers want and value most highly and social welfare is maximised
what is productive effiency?
- when product are produced at the lowest average cost so the fewest resources are used to produce each product
- only occurs when firms produce at the bottom of the AC curve
- in the short run this is MC = AC
- only possible if their is technical efficiency
What is dynamic efficiency
- when resources are allocated efficiently over time
- concerned with investment which brings new production techniques (falling LRAC)
- affected by short run factors such as demand, interest rates and past profitability
- supernormal profits required
- short run costs might be increased in order to cause long run costs to fall
what is the alternative to dynamic efficiency
Static efficiency
(Productive and allocative efficiency)
what is X inefficency
- when a firm fails to minimise its average cost at a given level of output
- not on minimum point on AC curve
- could be due to organisation slack, waste in production process, poor management etc.
- tends to occur in monopolies due to lack of competition
Evaluate dynamic efficeincy
- long time lag between making an investment and having falling average cots and consider how factors change in the long run
- firms will face a trade off between giving shareholders dividends and making an investment
what are the characteristics of a perfectly competitive market?
- many buyers and sellers
- sellers are price takers
- free entry to and exit from the market
- perfect knowledge
- homogenous goods
- firms are SR profit maximisers
- FoPs are perfectly mobile
In a perfectly competitive market what is price determined by?
The interaction of demand and supply
Firms are price takers
Why are profits lower in a competitive market?
- Market power for firms in a competitive market is much lower.
- if firms make a profit new firms will enter the market, increasing supply and lowering average price
Can firms make supernormal profits in a perfectly competitive market in the short run
Yes
What is the industry and firms diagram for a perfectly competitive market
Why do profits change in the long run for a perfectly competitive market?
- new firms enter
- supply increases
- price level in market falls
- firms are price takers so accept this new lower price
- competitive pressure ensures equilibrium is established
What are the advantedges of a perfectly competitive market?
- in the long run there is lower price P=MC so there is allocative efficiency
- since firms produce at the bottom of the AC curve there is productive effiency
- the supernormal profits produced in the short run may increase dynamic efficiency through investment
What are the disadvantages of a perfectly competitive market
- dynamic efficiency may be limited in the long run due to the lack of supernormal profits
- firms are small so there are few or no economies fo scale
- the model rarely applies in real life. Branding, prod diff., adverts and positive and negative externaliti mean competition is imperfect
what does Supply and demand equal in perfect competition
MC = S
MB = D
Why does MC split from Supply
because of negative externalities or lack of perfect competion
why does marginal benefit split from demand?
- public goods, MB is big despite D be very low
- free rider
What determines price in a perfectly competitive market?
Short run:
- demand
Long run:
- Average total cost
how do you figure out a firms output level of the firm at any given price in a perfectly competitive market?
- MR = AR
- MR = MC
- AR = MC
- P = MC = S (if perfect competition)
Firms are producing at the allocatively efficient point
Market equilibrium + social optimum are at the same quantity
Describe a monopolistically competitive market
- imperfect competition
- ## firms are short run profit maximisers
Describe the products within a monopolistically competitive market
- Firms cell non-homogenous products due to branding (product differentiation)
- Lots of relatively close substitutes. Making XED of goods and services high
Describe how many firms are in a monopolistically competitive market
- large number of buyers and sellers which are relatively small and act independently
- each seller has a small amount of market power which is the same as other sellers
- no barriers to entry or exit
Describe the demand curve in a market which has monopolistic comeption
- downward sloping demand curve
- firms can raise prices without losing all customers
- firms have some degree of price setting power
What type of information do buyers and sellers in a monopolistically competitive market have?
imperfect
What sort of profits can firms making in a market with monopolistic competition in the short run?
Super normal profits
Why cant firms make supernormal profits in the long run in a monopolistically competitive market
- New firms have entered the market since they saw the supernormal profits in the short run
- demand for existing firms products become more price elastic, shifting AR downwards
- firms can try and stay in the short run by differentiating their products and innovating
how does brand loyalty play a part in monopolistic competitive markets
Raises barrier to entry
Makes demand more inelastic
When are companies price setters within monopolistically competitive markets?
- when there is an exogenous shock which makes demand high (short run equilibrium)
- in the long run, more firms will enter (price takers)
Why is a monopolistically competitive market a market failure?
Profit Max: MR=MC
AR>MR (demand is not perfectly elastic)
AR>MC
P> MC
As demand curves are fairly elastic the industry will be fairly allocatively efficient but still a market failure
What are the advantages of a monopolistically competive market
- consumers get a wide variety of choice
- the model of monopolistic competition is more realistic than perfect competition
- supernormal profits produced in the short run might increase dynamic effiecieny through investment
What are the disadvantedge of a monopolistically competitive market?
- firms are allocatively inefficient in the short and long run (P>MC)
- firms do not fully exploit their factors, excess capacity in the market. Making them productively inefficient both in SR and LR
- in the LR dynamic efficiency might be limited due to the lack of supernormal profits
- firms are not as efficient as those in perfectly competitive market as they have X inefficiency due to less incentive to minimise costs
What is a monopoly?
- Profit maximisation: a monopolist earns supernormal profits in both the short and long run
- Sole seller in a market (pure monopoly)
- High barriers to entry
- Price maker
- Price discrimination
when do firms have monopoly power?
When one firm dominates the market with more than 25%
How does barriers to entry affect monopoly power?
The higher the barriers of entry the easier it is for firms to maintain monopoly power
What are examples of barriers to entry which can maintain monopoly power?
- Economies of Scale
- Limit pricing
- Owning a resource
- Sunk Costs
- Brand loyalty
- Set up costs
- Legal barriers
- Information imbalance
How do economies of scale allow monopoly power to be maintained
- as firms grow larger AC falls
- existing large firms have a cost advantage over new entrants
- new entrants cannot compete with existing firms
How does limit pricing allow monopoly power to be maintained
- existing firms can set the prices of their goods below the production costs of new entrants
- means that new firms cannot enter profitably
How does owning a resource allow monopoly power to be maintained?
- if an existing firms owns a scarce resource then new firms cannot access resources to enter the market (some energy companies own power generation facilities in the UK)
how do sunk costs allow monopoly power to be maintained?
- if unrecoverable costs are high, firms will be deterred from entering the market because they will not be able to get the value of their costs back
How does Brand loyalty increase firms monopoly power?
- built up by advertising
- new firms wont have customers and cannot gain market share
- Supply will be price inelastic
Why do set up costs increase monopoly power?
- if it is exspensive to establish the firm then new firms will be unlikely to enter the market
How do legal barriers act as barriers to entry
Patents prevent new firms from using original firms inventions without permission making it extremely hard to enter the market
how does an information imbalance act as a barrier to entry?
- new firms will have to spend exspensive time trying to figure out how an industry works while existing firms already have knowledge on the supply chain and customer base
What other factors can influence monopoly power?
- the number of competitors
- advertising
- the degree of product differentiation
How does degree of product differentiation/product proliferation affect monopoly power
- the more the product can be differentiated the easier it is to gain market share
- if existing firms have a wide range of products with different aspects, it will be harder. For new firms to find a niche
Why does the monopolist have the power to be a price-maker?
- the downward sloping market demand curve must also be the demand curve for the monopolists product
why are monopolists said to be constrained by their demand curves
- they can set the price for the quantity demanded by the consumers
- they must accept the price if they choose to cell a certain quantity
why do supernormal profits persist into the long run?
- because of high barriers to entry
- short and long run equilibrium are identical
Why is are monopolies allocaitvely inefficient
- the price charged by the monopolist is above its marginal cost
why are monopolies productively inefficient?
- output is below minimum average cost of production
why do monopolies have X inefficency?
- as entry barriers protect a monopolist it is under little pressure to behave efficiently and minimise costs
What are natural monopolies?
- Industries where the economies of scale are so large that even a single producer is not able to fully exploit them all.
- decreasing cost industries
- Royal Mail / national rail
Why is competition not encouraged in natural monopolies
Pointless
- will raise average costs for the industry
- if a new firm enters the market they will be easily priced out due to high starting costs
- raises questions of competition policy and nationalisation
- tend to be found in industries with very high fixed costs
what is the diagram for a natural monopoly?
What is a monopsony?
A single buyer in the market
E.g Network Rail for track maintenance
A firm with monopsony power is able to…
Negotiate lower prices and set market price
What is the diagram for a monopsonistic market?
What are the costs of a monopsonistic market?
- Suppliers are likely to lose profits due to negotiations
- Employees trained in supply this industry will have lower wages as they have little choice of who to work for - labour can be exploited and workers may be unproductive
What are the benefits of a monopsonistic market?
- the NHS has monopsonistic power when buying drugs from companies, therefore they can lower prices and spend money on R&D instead
- consumers receive lower prices due to lower price paid to suppliers
What is Baumols argument?
The main driver of firms behaviour is the threat of competition rather than competition itself. Firms would’ve be willing to sacrifice short run profits in order to dissuade potential competitors
What are the characteristics of contestavle markets?
- face actual and potential competition
- new entrants have access to production techniques and tech
- no barriers to exit or entry (no sunk cots)
- low consumer loyalty
- number of firms in the market vary
What are the implications of contestable markets
- firms are more likely to be allocatively efficient, in the long run firms operate at the bottom of AC making them productively efficient
- hit and run
- firms will produce normal profits in the short run to prevent attracting new entrants
What is brand proliferation
- disguises consumers from the actual market concentration
- the laundry soap market is owned by a few large conglomerates
What is an oligopoly?
When only a few firms supply the majority of the market
What are the characteristics of an oligopoly?
-
What are the characteristics of an oligopoly?
- high barriers to entry and exit
- high conc ratio
- interdependence of firm
- product differentiation
What does it mean when firms are ‘interdependent?’
- actions of a firm affect another firms behaviour
What is collusion
- two or more firms work together to influence a market or pricing to their advantage
What are the effects of collusion
- lower consumer surplus
- higher prices
- greater profits
What are the costs of collusion
- loss of consumer welfare (prices raised and output reduced)
- efficiency fails due to increased lack of competition (AC rises)
- lower quantity = less allocatively efficient
What are the benefits of collusion?
- industry standards could improve (collaboration of technology)
- dynamic efficiently (alternatively, dividends)
- saves on research and development
- EOS
What is a cartel?
- when two or more firms have agreed to control prices, limit output, or entrance of new firms
- OPEC 70% of oil production
- can lead to higher prices and restricted outputs
What is price leadership
- when one firm changes their prices and other firms follow
- explains why there is price stability in an oligopoly
What is game theory?
- used to explain the concept of interdependence between firms in an oligopoly
- predicts the action of one firm when it has incomplete information about the other
What is the dominant strategy?
- the option which is best, regardless of what the other firm chooses
What is the Nash equilibrium?
- the optimal strategy for all players, whilst taking account what opponents have chosen (collusion)
What makes the Nash equilibrium unstable
- incentives to cheat
What are the types of price competition
- price war
- predatory pricing
- limit pricing
What is a price war
- involves firms constantly cutting their prices below that of its competitors
- UK supermarket industry
What is predatory pricing?
- involves firms setting low prices to drive out firms already in the market
- involves making losses
What are the types of non price completion
- Brand loyalty
- advertising and markets (maybe ineffective)
Is profit maximisation always the sole objective in oligopolistic market?
No
- may be to maximise market share instead
What is sweezys theory
- firms are unlikely to change their costs in an oligopoly so firms choose to keep prices stable
What does the kinked demand curve represent?
- Price rigidity
- interdependence
What is price discrimination?
- when a firm charges different prices to different consumers on identical goods with no difference in costs of production
What are the conditions required for price discrimination
- price making ability (monopoly power)
- information to separate the market in different PDs
- prevent resale (market seepage)
What is third degree price discrimination
- when a firm is able to segment the market into multiple PED (inelastic and elastic)
What is the diagram for 3rd degree price discrimination
:
What are the cons for price discrimination?
- Allocative inefficiency (higher prices)
- inequalities
- anti-competitive pricing
What’s are the pros of price discrimination?
- dynamic efficiency
- economies fo scale
- cross subsidisation
What is cross subsidisation
- higher profits may be used to fund loss making goods
What can the size of firms be determined by?
- Economies of scale relative to market size (EOS may be limited in the industry)
- diseconomies of scale
- small firms as monopolists
- profit motive
- market power
- diversification
- owner objectives
What is the divorce of ownership?
When shareholders and managers have different objectives that may conflict
- Mangers: maximise bonus
- Shareholders: maximise dividends
What is organic growth?
When firms grow by expanding their production through increasing output, widening consumer base, developing new product or diversifying the range.
What is inorganic growth?
Through merging, acquiring or taking over a firm
What are the advantedges of organic growth?
- less risky
- firms grow by building upon their strength and using their own funds, firm is not building up debt and growth is more sustainable
- shareholders retain their control
What are the disadvantedges of organic growth
- takes longer
- reliance on strength of the market to grow
What is vertical integration?
When a firm merges with or takes over another firm in the same industry but at a different stage of production.
What is forwards vertical integration?:
- when the firm integrates with another fir4mr closer to the consumers
- involves taking over a distributor
What is backwards vertical integration?
- When a firm integrates with a firm closer to the producer
- taking over a supplier
What are the advantages of vertical integration?
- they can increase their effiency through gaining economies of scale which reduces AC
- firms can train more control of the market (can control price of supplies for other firms - cost advantage)
- more certainty over production (quality, quantity and price)
What are the disadvantages of vertical integration?
- diseconomies of scale
- barrier to entry - could make market more inefficient
What is horizontal integration?
- merger of two firms in the same industry at the same stage of production
What are the advantages and disadvantages of horizontal integration
- firms can grow quickly giving them competitive edge, this can lead to MONOPOLY POWER AND LOWER INEFFICIENCY
- can increase output quickly, taking advantage of economies of scale
- expertise and cut costs
- disagreements
What is conglomerate integration
The merging of two firms in different industries
What are the advantages and disadvantages of conglomerate integration?
- wider consumer base, market competition reduced
- both firms become stronger in the market than if they were individual
- EOS, and risk bearing EOS
- too much risk bearing EOS
What are constraints on businesses growth
- Size of the market
- Access to finance
- owner objectives
- regulation
- macroeconomic factors
How does the size of the market affect business growth?
Small markets may have limited opportunities for business expansion
- limited consumer market
- limited opportunities for expansion and innovation
Why may MES be very low output
- some industries do not benefit much from large-scale production
- low fixed costs
- small/localised demand
- technological constraints
- gov regulation
How does access to finance constrain businesses growth?
- without sufficient access to credit, firms cannot invest, innovate or grow as much
Why might owner objectives constrain business growth?
- maximising social or environmental welfare
- maximise bonuses or reputation
How does regulation act as a constrain on business growth?
- limits the quantity of output that a firm produces
- environmental laws/taxes or excessive corporation tax
How do macroeconomic factors can influence a firms growth?
- recession leads to low levels of demand
- recession may reduce investment
- globalisation has given much larger markets
- FDI into firms leads to improved financial account q
What is the Tesco booker merger?
- 3.7 billion deal in march 2018
- UKs largest supermarket chain aquifer booker group (wholesaler - supplies to convenience restaurants and stores)
Why did the CMA approve the Tesco-booker merger?
Two different industries
Why did Tesco buy booker?
Aimed to strengthen its position in the food market by expanding into wholesale sector.
How did Tesco save costs by acquiring booker?
£200 million in annual synergies from the merger through better supply chain management, increased PPP and reduced costs
Why may businesses profit maximise? -
- High revenues for R&D -> growth
- shareholders and owners driving this decision
- predatory pricing later on
- cash reserves
Why is Apple a profit maximiser?
- inelastic PED - brand loyalty - stronger pricing power
- premium prices
- strategic acquisitions
Why may firms not profit maximise?
- Divorce of ownership (differnet people managing day to day operations)
- misalignment of goals
- asymmetric information - managers can do as they please (increase bonuses instead of profit max)
- leading to corporate governance (boards of directors) vto oversee management
Why might a firms revenue maximise?
Amazon
- to expand market share through agressive pricing strategies, extensive options, significant investment into tech
What is sales maximisation
Selling as much as you can without making a loss. Measure of size of firms and suggests dominance in the markets.
AC = AR
Uber eats
What is satisficing
Business is making enough profit to keep shareholders happy
