The Theory of the Firm Flashcards
Define normal profit
the situation where a firm makes sufficient revenue to cover its total costs and remain competitive within an industry
Define abnormal profit
any profit above normal profit
What is the point of productive efficiency?
MC = AC
Define productive efficiency
producing goods and services with the optimal combination of inputs to produce maximum output for the minimum cost
What is the point of allocative efficiency?
MC = AR, also P = MC
Explain why the point MC = AR is allocatively efficient
as the value that consumers place on a good or service (reflected in the price they are willing and able to pay) equals the marginal cost of the scarce factor resources used up in production
When does allocative efficiency occur?
when there is an optimal distribution of goods and services, taking into account consumer’s preferences
Define consumer surplus
the difference between what consumers were willing to pay, and what they actually pay
Define producer surplus
the difference between what producers are willing and able to supply a good for and the price they actually receive
When does dynamic efficiency occur?
in the long-run
What is dynamic efficiency linked to?
the pace of innovation and investment, leads to the improvements in the performance and quality of the product
What is needed for dynamic efficiency to occur?
supernormal/abnormal profits
What is X-inefficiency?
where a lack of effective/real competition in a market or industry means that average costs are higher than they would be with competition
Give 4 characteristics of a monopoly
- 25%+ of market share
- price makers
- profit maximising
- abnormal profits
- high barriers to entry
Give 4 characteristics of a oligopoly
- few firms control majority of the market share
- high barriers to entry and exit
- sticky or rigid prices
- firms are interdependent
- non-price competition
- some product differentiation
- profit max is not the sole objective
- incentive to collude (act like monopoly)
- 5 firm concentration ratio > 50%
Draw a kinked demand curve
Give 4 characteristics of monopolistic competition
- large number of small buyers and sellers
- few and low barriers to entry
- good knowledge/information
- goods are non-homogenous / goods are slightly differentiated
- Firms are profit maximisers
Draw a graph for Monopolitically competitive firms in the short run
Basically the monopoly diagram, they produce at MR = MC
Draw a Monopolitically competitive firms in the long run
Order of drawing: AR/MR, MC, Profit max, AC, Marginal cost hits minimum of average cost
Are monopolistically competitve firms…. efficient
Allocative efficiency: N
Give 4 characteristics of perfect competition
- large number of small buyers and seller (theoretically infinite)
- no barriers to entry
- perfect knowledge/information
- goods are homogenous
- price takers
- no abnormal profits made in the long-run
Give 3 characteristics of a perfectly contestable market
- no barriers to entry or exit
- there are no sunk costs
- perfect information and access to all existing technologies
- there is a POTENTIAL for competition
Explain why a firm in perfect competition cannot make abnormal profits in the long-run
- due to no barriers to entry, any abnormal profits will attract new entrants into the industry
- this increases the market’s supply, reducing the price until all abnormal have been competed away
Explain why a firm in perfect competition will not make a loss in the long-run
- due to no barriers to entry, if firms are making a loss, some will choose to leave the market
- this will decrease supply, pushing up price until no losses are being made
What profit is made in the long-run in perfect competition?
normal profit
What efficiencies does a perfect competition firm operate at in the long-run?
- productively efficient
- allocatively efficient
Perfect competition will only result in allocative efficiency if…
… there are no externalities (positive or negative) in the market
What is the profit maximising point?
MR = MC
What is the point of normal profit?
AR = AC
At what point will a monopoly operate at?
at the point of profit maximisation, where MR = MC
How could a monopoly be deemed as disadvantageous to the consumer?
- operating below the point of allocative efficiency
- thus there is a deadweight loss to society
How could a monopoly be deemed as advantageous to the consumer?
- make supernormal profit, so can be dynamically efficient
- this could be used for investment, innovation, research and development, which could reduce costs in the long-run
- this could then be passed onto the consumer in terms of lower prices
Give 3 determinants of monopoly power
- high barriers to entry
- low number of competitors
- advertising and product differentiation
Give 2 types of barriers to entry
- legal barriers
- absolute cost barriers
- relative cost barriers
Give 2 types of legal barriers to entry
- licences
- patents
Explain what is meant by absolute cost barriers
the large amount of capital required to set up a firm in some markets
Explain what is meant by relative cost barriers
- AC of new firms is higher than AC of incumbent firms
- incumbent firms enjoy economies of scale and the benefits of R + D