Theory of a Firm

Question 1

Backwards Vertical Integration

Answer 1

A merger/takeover between two or more firms where one firm is further behind in the stages of production (e.g: Ikea acquiring a pine forest for the production of their furniture)

Question 2

Forward Vertical Integration

Answer 2

A merger/takeover between two or more firms where one firm is further ahead in the stages of production (e.g: an airline acquiring a hotel chain)

Question 3

Horizontal Integration

Answer 3

Merger/takeover of two or more firms that are in the same industry, at the same stage of production

Question 4

Merger

Answer 4

Two or more firms mutually joining together to create a new independent business

Question 5

Acquisition/Takeover

Answer 5

The purchase of a firm by another firm. The purchased firm then becomes part of the purchasers’ firm.

Question 6

Demerger

Answer 6

When a firm splits to create two or more smaller independent firms

Question 7

Economies of Scale

Answer 7

When a firm’s average cost of production falls as their output rises

Question 8

Economies of Scope

Answer 8

The efficiencies gained from producing a variety of goods, not a volume of goods

Question 9

Total Revenue (TR)

Answer 9

The total amount of money a firm receives from it’s sales in a given time period

Question 10

Marginal Revenue (MR)

Answer 10

The extra revenue received from selling one additional unit of output

Question 11

Average Revenue (AR)

Answer 11

The revenue per unit sold (Total revenue / Quantity Sold)

Question 12

Market

Answer 12

All the firms supplying a particular good and all of the firms/individuals buying said good

Question 13

Profit

Answer 13

Total revenue (TR) - (TC) Total Costs

Question 14

Total Cost (TC)

Answer 14

All of the costs for a firm involved in producing a particular good at a particular output

Question 15

Average Cost (AC)

Answer 15

The cost of production per unit of output (Total Cost / Quantity Produced)

Question 16

Average Fixed Cost (AFC)

Answer 16

Total Fixed Costs / Quantity Produced

Question 17

Average Variable Costs (AVC)

Answer 17

Total Variable costs / Quantity Produced

Question 18

Marginal Costs (MC)

Answer 18

The extra cost incurred as a result of producing the final unit of output (Cost of producing ‘one more’ unit)

Question 19

Law of Diminishing Returns

Answer 19

If one variable factor of production increased while other factors stay fixed, eventually the marginal returns from this variable factor will begin to decrease

Question 20

Marginal Returns

Answer 20

The additional output produced by adding one more unit of the factor of production already being utilised

Question 21

Organic Growth

Answer 21

Growth of a company by investment and increasing the labour force. Very few companies grow in this manner as it is quite slow however it is very controllable and costs can be predicted.

Question 22

Inorganic Growth

Answer 22

Growth of a company via acquisition/takeovers. Most companies grow in this manner as it is fast and results in immediate profit or loss. However, this can be uncontrollable and too fast for some companies to keep up with - (e.g: the case of Japan Airlines and their acquisition of a hotel chain (Nikko Hotels) and inability to adapt to the new acquisition led to the company filing for protection after a $25 billion bankruptcy case. The hotels were then sold off to Okura in order to make up losses)

Question 23

Variable Costs Explanation

Answer 23

All costs are variable in the long run and will vary with output (e.g: the overall cost of plastic bags will increase as the number of sales increases)

Question 24

Why are Fixed Costs incurred in the short run?

Answer 24

In the short run, at least one factor of production is fixed and cannot be changed. Therefore, fixed costs are incurred for the fixed factor.
Fixed costs have to be paid whether or not any product is sold. (e.g: Rent on a shop must be paid whether or not the tenant sells any of their products)
In the long run, fixed costs are incurred and all costs are variable as all factors of production are mobile.