Theory Of The Firm Part 1

Question 1

Define the law of diminishing marginal utility

Answer 1

As the number of units consumed increases, the utility derived from each additional unit of consumption decreases

Question 2

What is the marginal principal

Answer 2

Economic agents may take decisions by considering the effects of small change from their existing situation
- relies on economic agents being rational

Question 3

How does price vs marginal utility affect consumer behaviour

Answer 3

• when price > MU, consumers will not consume
• when price < MU, consumers will consume more
• when price = MU, allocative efficiency

Question 4

Why is the marginal utility curve essentially equal to the demand curve

Answer 4

The satisfaction a consumer places on a good determines the value they place on it
E.g. if higher than the price, will buy it

Question 5

Equi-marginal principle

Answer 5

MUx / MUy = Px / Py

Question 6

Fixed costs

Answer 6

Costs that don’t change with level of output

Question 7

Variable costs

Answer 7

Costs that don’t change with level of output
E.g. wages, packaging

Question 8

Formula average cost

Answer 8

Total cost / total output

OR

AFC + AVC

Question 9

Total cost formula

Answer 9

TFC + TVC

Question 10

Marginal cost formula (MC)

Answer 10

Changing in TC / change in total output

Question 11

The short run is the time period in which

Answer 11

At least one FoP is fixed - normally capital
All FoPs can become variable in the long run

Note - some labour costs are variable in short run e.g. zero hour contracts

Question 12

Define law of diminishing returns

Answer 12

As the input of variable factors is increased, the addition)al output produced by each additional unit of input falls, meaning average cost increases ( U shape)

Question 13

Define internal economies of scale

Answer 13

A reduction is a firms long run average costs as a result of increasing output or scale of operation

Question 14

Types of internal economies of scale

Answer 14

Purchasing - essentially bulk buy
Technical - big businesses can buy more tech - benefit more from technological advances
Marketing - larger firms can spend their advertising over larger amounts of output
Managerial - larger firms can hire expert specialists to improve efficiency
Risk bearing - larger firms can diversify more - so spread risk more - less likely to have high costs
Financial - larger firms can get better loans from banks cuz seen as less risky

Question 15

Internal diseconomies of scale

Answer 15

Slower decision making - numerous levels - tall hierarchy structure so takes longer to make decisions - less productivity and slower response to market changes so AC increases

Poor coordination - if too many branches or departments, managers can’t oversee everything - less productivity so less output so AC increases

Worker productivity decreases - when size increases, firms will take some decision making power away from employers - less motivated so less productive so less output so AC increases
When many employees, more disputes so less productivity less output AC increases

Question 16

The most commonly drawn average cost curve shows a firm experiencing internal economies of scale then diseconomies of scale

Answer 16

• looks like a U shape
  Part with negative gradient is EOS
  Part with positive gradient is DEOS
  The minimum point is the minimum efficient scale

Question 17

What is the minimum efficient scale and what does it say about the market the firm is operating him

Answer 17

MES - the lowest level of output at which a firm can produce output at the lowest cost
When MES is closer to 0, it’s a more competitive market
When MES is further from 0, is is a less competitive market - dominated by a few large firms

Question 18

What does an average cost curve look like for a firm in an industry where diseconomies of scale don’t occur

Answer 18

Down sloping with negative gradient
Gets less steep as output increases
Kinda like the bottom left corner of a circle

Question 19

Why do firms who enjoy a natural monopoly not have diseconomies of scale

Answer 19

Initially, high costs for setting up e.g. building water networks for a water company
But cuz of this, few firms are able to,e to enter market due to high initial cost
Overtime, AFC falls as output increases with expansion
They don’t need to spend on more networks as there is little competition