Revenues, costs, profits and objectives

Question 1

Define short run.

Answer 1

period over which firm is free to vary the input of one of its factors of production but not all

Question 2

Define long run.

Answer 2

period over which firm is free to vary the input of all of its factors of production

Question 3

What are sunk costs?

Answer 3

short-run costs that cannot be recovered if a firm closes down

Question 4

What are fixed costs?

Answer 4

costs that do not vary with level of output

Question 5

What are variable costs?

Answer 5

costs that vary with level of output

Question 6

Define marginal cost.

Answer 6

cost of producing an additional unit of output

Question 7

Define economies of scale.

Answer 7

when an increase in a firm’s scale of production leads to production at lower long-run average cost

Question 8

Name three possible sources of economies of scale.

Answer 8

1. specialisation of labour
2. technology (eg larger lorry uses less fuel per unit)
3. indivisibilities (eg can’t use combine harvester in small field)

Question 9

Define a natural monopoly.

Answer 9

monopoly that arises in an industry where there are substantial economies of scale but only one firm is viable, eg London Underground

Question 10

What are management economies of scale?

Answer 10

economies of scale that arise when a larger firm is able to rationalise its management structure or improve the cost-effectiveness of its marketing

Question 11

What are financial economies of scale?

Answer 11

economies of scale that arise when a larger firm is able to get better terms on its borrowing because of its size

Question 12

What are purchasing economies of scale?

Answer 12

economies of scale that arise when a larger firm can obtain better terms from its suppliers

Question 13

What are technical economies of scale?

Answer 13

economies of scale that arise when increasing size allows improved technical efficiency

Question 14

What are diseconomies of scale?

Answer 14

occur for a firm when an increase in the scale of production leads to higher long-run average costs

Question 15

What are constant returns to scale?

Answer 15

when long-run average cost remains constant with an increase in output, ie when outputs and costs rise at same rate

Question 16

What are internal economies of scale?

Answer 16

economies of scale that arise from the expansion of a firm

Question 17

What are external economies of scale?

Answer 17

economies of scale that arise from the expansion of the industry in which a firm is operating

Question 18

What is productive efficiency?

Answer 18

when firms have chosen appropriate combinations of factors of production and produce maximum output possible from those inputs, thus producing at minimum long-run average cost

Question 19

What is minimum efficient scale?

Answer 19

level of output at which long-run average cost stops falling as output increases

Question 20

Define normal profit.

Answer 20

profit that covers opportunity cost of capital and is just sufficient to keep the firm in the market

Question 21

Give three terms for profits that exceed normal profit.

Answer 21

1. supernormal profits
2. abnormal profits
3. economic profits

Question 22

Define marginal revenue.

Answer 22

additional revenue gained by firm for selling an additional unit of output

Question 23

On an output v revenue graph, where is profit maximised?

Answer 23

When marginal revenue equals marginal cost and marginal cost cuts marginal revenue curve from below

Question 24

What is the shut-down point?

Answer 24

point below which a firm will cease production in the short run, as its price is not covering its variable costs

Question 25

What objectives might managers have that would not necessarily maximise profit?

Answer 25

1. maximise market share
2. maximise number of people in their team
3. managerial perks, eg large office, company car

Question 26

Name four reasons why a firm might continue in business in short run if is not covering its opportunity costs?

Answer 26

1. As already paid its fixed costs, as long as it covers variable costs it is better staying in business.
2. It expects to be able to increase profits in future, eg due to lower costs or higher sales.
3. Costs of closure, eg redundancies, are higher than keeping going.
4. It is deliberating setting prices low to force competitors out of business (and would then increase prices).

Question 27

Define satisficing.

Answer 27

behaviour of managers aiming to produce satisfactory results rather than best possible results

Question 28

What is bounded rationality?

Answer 28

when firm’s ability to take rational decisions is limited by lack of information or inability to interpret information available

Question 29

What is corporate social responsibility?

Answer 29

actions taken by form to demonstrate its commitment to behaving in public interest