Theme 3

Question 1

How do economists and accountants differ in their view of costs?

Answer 1

• Accountants: include internal costs e.g. rent, energy bills and wages
• Economists: include all the above + opportunity cost

Question 2

Profit

Answer 2

Revenue - Costs

Question 3

Normal profit

Answer 3

• If revenue and costs (private and opportunity) are equal a firm is said to earn normal profit
• Is the minimum reward necessary to keep factors of production in their present use
• If a firms fails to earn normal profit it would stop to produce in the long run

Question 4

Supernormal profit

Answer 4

If revenue is higher than costs (private and opportunity) a firm is said to earn supernormal profit

Question 5

To maximise profits:

Answer 5

The firm needs to choose the output level at which total revenue is as far above the total cost curve

Question 6

Shutdown Points

Answer 6

• The shutdown point for a perfectly competitive firm occurs when the firm is not covering average variable costs
• It may be feasible for a firm to make a loss in the in the short run as long as it covers the variable cost of making the good + therefore makes a contribution to the fixed costs

Question 7

What are the short and long run shutdown points?

Answer 7

• Short run shutdown points: when price is below AVC
• Long run shutdown points: when price is below AC

Question 8

Productive efficiency (MC=AC)

Answer 8

• Occurs at the lowest cost per unit of output or the lowest point of the average cost curve
• The firm is producing as much as possible relative to inputs
• It is where the MC interests the AC

Question 9

Allocative efficiency (P=MC)

Answer 9

• Occurs when the cost of production + the demands of consumers are taken into account to maximise welfare (S=D)
• Firms will charge a price equal to the MC of manufacturing the good
• It is where the price charged for the last unit (the amount people are prepared to pay) is equal to the cost of making the last unit so net welfare falls if any more units are produced
• It is also called welfare maximisation

Question 10

Dynamic efficiency

Answer 10

• Looks at how changes in technology + productive techniques (R&D) over time will increase the productive potential of a firm
• This is very distinct from productive + allocative efficiencies which are assumed to be static

Question 11

X - inefficiency

Answer 11

• Occurs when the average cost of higher than the lowest possible average cost (the firm operates above its AC curve)
• This can happen in highly concentrated markets such as monopoly (more than 25% of market share) + oligopoly (few large suppliers e.g. Pepsi) where firms are able to make supernormal profits + have an AR that is greater than the AC thus reducing the need or desire to lowers AC + decrease x-inefficiency