Theme 3 - Firms, costs and profit Flashcards
What is the main objective of a firm?
The main objective of a firm is to maximize profit (Profits = Revenue - Costs)
How do you compute revenue?
Revenue is equal to : π=π· π πΈ
What is the trade-off that producers face?
sell less units at a higher price or sell more units at a lower price
What is the elasticity of revenue with the respect to price and how do you compute it?
Er gives the percentage change in revenue in response to a 1% change in price
Er = 1+Ep
When is revenue maximized and how can an industry increase revenue?
When is revenue maximized: If EP = β1 then ER = 0
How can an industry increase revenue?
β P leads to an β R when demand is inelastic (-1< EP < 0)
β P leads to an β R when demand is elastic (EP < -1)
(When demand is inelastic, industry revenue increases when the price rises. When demand is elastic, industry revenue decreases when the price rises.)
What characterizes economic decision-making?
Past should be taken as given and decisions should be forward looking
Describe accounting costs, sunk costs, opportunity costs and economic costs and give the formula to compute economic costs
Accounting costs: monetary outflows corresponding to transactions made to acquire inputs
Sunk costs: the result of a monetary transaction that is now out of your control
Opportunity costs: the value of the best alternative use of that resource
Economic costs: the costs that are relevant to decision making
Formula: (Accounting costs - Sunk costs) + Opportunity costs = Economic costs
How do you compute accounting profit and economic profit?
Accounting profit = Revenue - accounting costs
Economic profit = Revenue - accounting costs + sunk costs - opportunity costs
How do you compute total cost, marginal cost, average cost, average fixed cost and average variable cost?
Total cost: C(q)= F+ VC(q)
Marginal cost: MC(q)= Cβ²(q)= (dC(q))/dq
Average cost: AC(q)= C(q)/q = (F +VC(q))/q
Average fixed cost: AFC(q)= F/q
Average variable cost: AVC(q)= VC(q))/q
Draw the typical cost curves
I canβt insert images but the answer is in the PP theme 3 diapo 37
MC intersects both AC and AVC when these curves reach their minimum.
When do we say that a production exhibits economies of scale?
If its average cost decreases when output(Q) increases
What can we do in the short run?
The duration is too short to adjust all production factors
- Some inputs are fixed (because there is not enough time to adjust)
- Market frictions: contracts with suppliers, lease on a building, etc.
You canβt really change the size of your business
What can we do in the long run?
The duration is long enough to allow for all production factors to be adjusted
- The use of inputs is not constrained (e.g., the size of a plant, contracts with providers, etc.), e.g.: enough time passes so that all inputs are variable.
- Materials, labor and physical capital are all variable, so all costs (L, K, M) become variable.
The duration of this period is not universal, depends on the industry.
When does a firm maximizes profits?
When MR(q) = MC(q)
