Theory of The Firm (Beginning of topic) Flashcards
What type of assumption is it that a firm a firm aims to profit maximise
A neo classical assumption
Firms are owned by shareholders and run by the B.O.D, what is this known as
The divorce of ownership and control
How do shareholders make money
Capital appreciation
Through dividends
Why do shareholders want profit maximisation
Increased dividends
Why do the B.O.D want profit maximisation
Job security (may mean less risk taking)
Salary maximisation (may mean growth over profit)
What is an AGM
Annual General Meeting
What occurs in an AGM
General meeting & the shareholders vote as to whether they want to re-elect the board of directors
What is the definition of the long run
All factors of production are variable
What is the definition of the short run
At least 1 factor of production (usually capital) is fixed
What is the definition of production
Converting inputs into output
What is productivity?
A measure of efficiency
What is as a marginal cost
The extra cost incurred from producing one more unit of output
What is marginal revenue
The extra revenue gained from selling one more unit of output
Draw the diagram showing supernormal profit
What is the profit maximising level of output
Where marginal costs (MC) are equal to marginal revenue (MR)
What do marginal costs represent on the normal/supernormal profit diagram
Supply
What does Average Revenue represent on the normal/supernormal profit diagram
Demand
Why is the profit maximising point where marginal costs are equal to marginal revenue ?
Because at output levels before this point, you add more to revenue than cost, after this point you add more to cost than revenue
What is normal profit
The minimum required to keep 1 factor of production in its present use
What does supernormal profit provide the incentive for firms to do
Supernormal profit provides the incentives for factors of production to leave their current employment and re-deploy in the industry where supernormal profit can be made
What is the main definition of a monopoly
A firm that is able to to influence price & quantity in the market
(They have market and pricing power)
Draw the diagram showing normal profit
What type of profit does a monopoly make in the long run
supernormal
Why is a monopoly able to make supernormal profit in the long run
Due to barriers to entry
What are barriers to entry
Factors which make entering a market difficult
What is productive efficiency
The lowest point on the average cost curve
Why are monopolies not productively efficient
They produce where mc=mr, not at the lowest point on the average cost curve
How does the presence of supernormal profit lead to dynamic efficiency
Supernormal profit can lead to re-investment leading to lower long run average costs
What is dynamic efficiency
Re-investment leading to lower long run average costs
At what point is total output maximised
Where marginal revenue = 0
C
When do firms shut down in the short run
If variable costs are not covered
If variable costs are covered with a little over, it makes sense to stay in the market as fixed costs such as rent will remain even if you leave the market due to lease agreements etc. So by staying in the market and covering even a little bit of the fixed costs the business owner is benefiting
If not even variable costs are covered as well as fixed costs then there’s it’s a loss when staying in the market
If variable costs are covered but no fixed costs are covered, it doesn’t matter which you pick financially the outcome is the same
Draw a diagram showing the different objectives of firms
Give 3 roles of profit
Investment in Research & Development (increasing efficiency and innovation)
Reward for shareholders
Attract new firms into an industry (signals demand)
Enable higher wages for workers
Tax revenue for gov (Corporation tax)
Give 5 objectives of firms
Profit maximisation
Sales maximisation
Increased market share/market dominance
Social/environmental concerns
Profit statisficing
What is profit statisficing
In many firms, there is a separation of ownership and control. Those who own the company (shareholders) often do not get involved in the day to day running of the company.
This is a problem because although the owners may want to maximise profits, the managers have much less incentive to maximise profits because they do not get the same rewards, (share dividends)
Therefore managers may create a minimum level of profit to keep the shareholders happy, but then maximise other objectives, such as enjoying work, getting on with other workers. (e.g. not sacking them) This is the problem of separation between owners and managers.
Give 4 barriers to entry
Brand loyalty
Economies of scale
Patents
Significant capital requirements
Give 4 sources of monopoly power
Barriers to entry
Advertising
Product differentiation
Lack of consumer information
Formation of a cartel
How does Lack of consumer information mean monopolies have more power
As consumers are unaware of all of their options and therefore may be deceived into buying a certain product, allowing monoply power to build up.
How does advertising and product differentiation mean monopolies have more power
Advertising and product differentiation can help to enlarge perceived differences in products. This reduces the elasticity of demand for certain products and enables one firm to take control of a market, e.g. Apple.
How does advertising and product differentiation reduce the elasticity of demand for certain products
Advertising and product differentiation can reduce the elasticity of demand by making consumers perceive a product as unique or essential, meaning they’re less likely to switch to alternatives, even if prices rise
