Theory of the Firm Flashcards
What is the definition of short and long run?
The short run period is the time period when at least one factor of production is fixed. When all factors of production become variables, this is called the long run period.
What is the law of diminishing returns?
increased variable factors of production added to the production process, when at least one factor of production is fixed, will at some point result in falling marginal output.
What is an imperfect market?
An imperfect market structure, or imperfect competition, is a market structure where firms have some price setting ability and consumers are limited in some way of switching between firms.
What goals may firms want to pursue?
- Profit maximisation
- Revenue maximisation: This would increase units sales, and increase customer base possibly improving sales in the long term
- Growth Maximisation: this could be achieved via predatory pricing
- Profit satisficing: just wanting to have fun
What is predatory pricing?
refers to firms charging very low prices in order to gain more market share in the industry. It may involve sacrificing profits or even incurring a loss.
What is the principal-agent problem
When the objectives of the owners of a firm and objectives of the firm’s managers being different.
What is perfect competition?
What are the characteristics?
Where there are a large number of small firms, each with no ability to set prices.
- Many small firms
- No ability to set price
- Perfect mobility of resources
- Goods are homogenous
- No barriers to entry
- They are both allocatively and productively efficient
What is a monopoly?
What are the characteristics of a monopoly?
A single firm is operating in the entire market
- strong barriers to entry and exit.(economies of scale, large start-up costs)
- There are no close subsitutes.
What are the disadvantages of a monopoly?
- They don’t have to be productively efficient
- They don’t need to be allocatively efficient
- They have no competition, so can exploit the market base. This generates a welfare loss
An example of government control in monopoly regulation
In 2017, the EU fined Google €2.42 billion for manipulating the shopping information displayed during web searches.
Advantages of a monopoly
They have the ability to divert profits to research and development
- e.g. drug industry
- Over time, the company can lower costs- economies of scale
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What is a natural monopoly?
Why do they exist?
a single firm can serve that market at lower cost than any combination of two or more firms ( OECD ). This is because of the large investments needed to provide this good or service and economies of scale won’t be achieved until much greater levels of output are produced.
What is monopolistic competition?
What are the characteristics?
- many small firms
- Similar, slightly differentiated products
- Low barriers to entry
- Each firm has some ability to set the price
- Demand is less steep(inelastic) than in a monopoly
What happens in monopolistic competition in the long run?
In the long run, supernormal profits make firms want to enter the market, as low barriers to entry. AR drifts left until it intercepts the ATC curve.
firms will engage in non-price competition. The more unique consumers think the product is, the more successful it’ll be.
Efficiency in monopolistic competition
They are not productively efficient- their goods differentiate
They are not allocatively efficient-brand loyalty
