The Firm

Question 1

What is the theory of supply?

Answer 1

The theory of how much output a firm chooses to produce

Question 2

What are the 3 types of firms?

Answer 2

1. Self-employed sole traders (sole proprietor), run by sole trader (unlimited liability)
2. Partnerships, run by more than 1 person (unlimited liability)
3. Companies (large firms): owned by shareholders (limited liability), run by board of directors

Question 3

What is revenue?

Answer 3

What the firm earns from sales before deducting costs

Question 4

What are costs?

Answer 4

Expenses incurred in producing and selling
Including opportunity cost (amount an input could obtain in its next highest paying use) of all resources used in production

Question 5

What are economic costs?

Answer 5

Cost of owner’s time and effort in running a business, including the opportunity cost of financial capital (by working in a company with a fixed salary) used in the firm

Question 6

What’s the main difference between accounting profit and economic profit?

Answer 6

That accounting profit does not take opportunity cost into consideration, hence why accounting profit is greater than economic profit (due to greater economic cost)

Question 7

What are fixed costs?

Answer 7

Cost that remains the same and does not vary with production of good x
e.g. fixed plant and machinery, rental cost of shop

Question 8

What are variable costs?

Answer 8

Cost that varies with the production of good x (the higher the production of x -> higher variable cost)
e.g. cost of labour

Question 9

Does profit always rise if we produce more outputs of good x?

Answer 9

No, because although TR rises when the producer sells more output of good x, the TC also rises along, making profit levels ambigious

Question 10

How do firms maximise profit?

Answer 10

If TC is assumed to be fixed:
Firm should increase X such that TR rises and profit rises (TR goes up, TC constant)

If TR is assumed to be fixed:
Firms should find technology that can reduce TC such that profit is maximised (TR constant, TC falls down)

Question 11

What are the types of profit?

Answer 11

1. Profit > 0 -> P(x) > AC (average cost) -> supernormal/supranormal/positive profit
2. Profit = 0 -> P(x) = AC -> normal/breakeven/zero profit
3. Profit < 0 -> P(x) < AC -> subnormal/negative profit/loss