Section three-Business Economics

Question 1

What is the law of diminishing returns ?

Answer 1

The law of diminishing returns explains what happens when a variable factor of production increases while other factors stay fixed

Question 2

What is the Marginal product ?

Also called Marginal returns

Answer 2

The Marginal product is the additional output produced by adding one more unit of a factor input

Question 3

How it works ?

Answer 3

Initially , as you add more of a factor of production the marginal product will increase.
This might happen because of specialisation is possible with more of a factor input.
Eventually if you keep adding units of one factor of production , the other fixed factors will being to limit the additional output you get and the marginal product will fall.

Question 4

What is the point of diminishing returns ?

Answer 4

The point where marginal product will begin to decrease as input increases

Question 5

Why are some firms price takers ?

Answer 5

Have no power to control the price they sell at .
A price takers curve will be completely flat , demand is perfectly elastic. If the firm increases the price then the quantity sold will drop to zero,

Question 6

Relationship of AR and MR in a perfectly elastic curve ?

Answer 6

Marginal revenue =average revenue because each unit sold brings in the same revenue as all the others
When average revenue is constant , total revenue increases proportionally with sales .

Question 7

Example of a price maker ?

Answer 7

Monopolist - have some power to set the price they sell at

Question 8

Profit fomrulae

Answer 8

Profit =TR-TC

Question 9

Profit formulae

Answer 9

Profit =TR-TC
TC consists of the money costs of the things that have to be paid for and the opportunity costs of the factors that are not paid for

Question 10

What is normal profit ?

Answer 10

Total revenue is equal total costs / economic costs
If the extra revenue is less than those opportunity costs , then the firm would have been better off putting the factors of production to different use
Normal profit is the minimum level of profit needed to keep resources in their current use in the long run

Question 11

Supernormal profit

Answer 11

TR greater than TC

Question 12

Profit in the short run/ Look at page 48 for diagrams

Answer 12

A firm has fixed costs that it has to pay , wheteher or not it produces any output-revenue should be compared to it’s variable costs

Question 13

Main objectives of a firm

Answer 13

-Revenue maximisation (MR=0)
-Profit maximisation (MC=MR)
Sales maximisation(AR=AC)

Question 14

Example

Answer 14

• Maximising profit in the long run sometimes means sacrfiicing profit in the short run
• A firm may try to maximise sales or revenue in the short run , e.g. a firm might maximise revenue or sales to increase it’s market share , or to gain monopoly power so it can make supernormal profits in the long
  run. High sales could also make it easier to borrow money.
• Also some firms may even be wiling to operate at a loss in the short run in order to make a profit in the long run. A firm may expect revenue to increase in the future . once they have been in the market for a while and their and brand recognition increases
• A firm objective may be to simply survive in the short run by achieving normal profit , then when it is established in the market, it can try to maximise profits.

Question 15

Alternative objectives

Answer 15

-Some organisations are not for profit - they don’t pay out profit to their owners and their main aim is to good
or provide some kind of benefit to the public.
-Other firms will focus on producing high quality products , at the expense of maximising profits in the short run, to gain loyal customers.

Question 16

What is the corporate social responsibility (CSR) ?

Answer 16

This involves firms operating in a way that brings benefit to the society , as well as trying to make supernormal profit.
Examples:
-A firm may try to protect the environment by using sustainable resources
-A firm may support local businesses by using suppliers in their region
-A firm may choose to pay its workers above the standard pay rate.

Question 17

Notes/ The objectives of firms/Divorce of ownership from control

Answer 17

• In small firms , the owner often manages the company on a day-to-day basis;
• As firms grow , the owners often raise finance by selling shares, the new shareholders become part owners of the firm. But the firm will be run by directors , who are appointed to control the business in the shareholders interest
• Directors might have different objectives to the owners.
• Employees and other stakeholders( includes everyone with an interest in or who is affected by the firm e. employees , managers, suppliers, customers,etc.

Question 18

What is the principal-agent problem ?

Answer 18

• This is where a principal(e.g. shareholders) pays for an agent (e.g. a managing director) to act in their interests , but instead the agents acts in their own self- interest.
• For example a firm’s shareholders will want a firm to maximise profits to increase the value of its shares. However , if the managing director’s pay or bonus is linked to revenue or sales , then they may choose to maximise those things instead.
• Directors might also be keen to grow some aspect of the firm ( e.g. sales or market share ) because they enjoy running a large organisation , or because being in charge of a firm will further their career,
• Employees (another example of an agent) are likely to aim to increase their own pay or benefits , ahead of aiming to make profits for the firm.