Topic 2 - Theory of Firm & Business Economics 1 Flashcards
Short run Production
at least one factor of input is fixed.
Long run production
all factors of production are variable
Production process
when manufacteurers take an input item and turn it into an end good
Capital goods
- goods that are used to make customer goods and services.
- capital inputs inculuded fixed plant and machinary, hardware, software, new factories and other buildings.
Consumer goods and services
- goods and services which satisfy our needs and wants directly
Subdivisions of consumer goods and services
consumer durables - provide a steady flow of satisfaction overt their working life. E.g. washing machine.
Consumer non-durables: products that are used up in the act of consumption e.g. drinking a coffee.
Consumer services: e.g. a haircut
Production definition
is a measure of the value of output of goods and services. e.g. measured by national GDP or an index of production in specific industry such as car manufacturing.
Productivity definition
a measure of the efficiency of factors of production measure by output per person employed, or by output per person hour.
Factors affecting labour productivity
- The degree of competition in a market will reduce the production growth of firms because competition can constrain buyers and sellers to be price-taken.
- Advances in production technology will increase productivity since improved tech can create lower costs of productions for firms. The quality and quantity of goods will also improve. E.g AI
- Specialisation (Division of labour) within a business - the more they focus on one task, the more efficient they become at that one task which means less time and money is involved in producing a good. e.g. factories producing cakes.
- Higher business investment in new capital outputs - when a business channel funds into capital, it creates the building blocks for a higher level of productivity in the future. e.g. land, buildings
- Investment in apprenticeship/ training to boost labour skills - workers are more skilled which means they can do more efficient job e.g. firms having training weeks.
What does a production possibility frontier do/show
Maximum possible production of 2 goods/ services with given factors of production.
The various combinations of 2 goods/services that can be produced with given factors of production.
What can manipulate a PPF diagram to show
Oppurtunity cost
Efficiency
Shifts of Production
Labour productivity definition
the measure of how much output is produced per unit of labout input, for instance per worker. Higher productivity means a business is using all of their factors of production to full affect.
How do specific factors of production contribute to economic output
Labour - an increase means more products are produced increasing the output
Land - access to more means you can build more factories to increase the economic output.
Capital - increase means you can invest more in raw material
Entrepreneurship - by taking a risk in an investment you are open to profiting from the investment.
Differences in factors of production between short term and long term
short term - one FoP is fixed.
long term - none of FoP are fixed.
long term uses FoP that can fluctuate and change.
How does the law of diminishing return apply to a firms decision making in the short run
it influences a firms decision by determing the optimal level of input to maximise output and minimise costs.
The law of diminishing returns states that as more of one input is added while other inputs are help constant there will eventually be a point where each additional unit of input will yield less additional output.
Division of labour
- when production is broken down in to separate task with workers doing specific tasks.
- the aim is to increase efficiency by allowing workers to focus on specific tasks.
- can raise output per person as people become proficient.
- lowers the supply cost per unit become people do there task faster.
What is specialisation
- a result of division of labour
- when different firms/regions/countries become specialise in the production of a narrow/limited range of goods and services
- they will then develop a compatible advantage.
Average product vs Marginal Product
Average product is the total product divided by the number of workers.
Marginal Product is the change in total product / change in change of workers.
When we employ our first few workers marginal product is rising becuase labour productivity increase for two reasons - specialisation and under uitilisation of fixed FoP. When we employ more than the peak Mariginal product we see a fall in Marginal Product because the fixed factors fo production constrain the productions.
Increasing returns to scale
when the output increases by a larger proportion than the increase in inputs
Constant return to scale
when the output change is of an equal proportion to the FoP.
Decreasing returns to scale
when the output is less than the change in FoP.
Fixed costs
expenses that remain constant regardless of the level of output
Variable costs
change with the level of output
Total costs formula
fixed + variable
Average fixed costs
the fixed costs which remain the same divided by the quantity produced
AFP = Total costs/ Output
Marginal costs
the change in cost from a business producing one extra unit of goods/services
Short run costs
includes both fixed and variable, but some costs stay the same
6 - 12 months
Long run costs
includes all costs including fixed and variable and all costs can be adjusted
Up to 5 years.
Economies of scale definition
a reduction in long run average cost as output increases.
Examples of internal economies of scale
Managerial - employing specialist managers
Technical - buying specialist machinery
Purchasing - buying raw material in bulk to negotiate discounts
marketing - bulk buying advertising
Financial - negotiate lower rates of interest when larger.
Risk bearing - when a business is larger they can spread the risks over a larger output, therefore lower average costs.
examples of external economies of scale
better transport infrastructure - railways - makes it cheaper to access raw materials
component suppliers move closer - it is in their interest to cut transportation cost.
R&D firms move closer to you - you are a key business so you can use their R&D and improve your technology.
Internal and external economies of scale definitions
Internal happen inside a business
external happen outside a business but in the industry
Dis economies of scale definition
an increase in long run average costs as output increase
Causes of dis economies of scale
loss of control - when the workforce becomes too large, managers will find too difficult to control all of the workforce and workers will see this and decide to slacken which causes their output to decrease.
communication - it will be much harder to send messages across a whole business therefore it is a waste of time and productivity costs rise.
Co-ordination - to make sure all parts of the business are working well together is difficult because you wont be able to always make sure they are working in the same way.
Motivation - each individual worker feels less valued so productivity is going to fall hence costs rise faster.
Normal profit
is the minimum reward required to keep entrepreneurs supplying their enterprise.
This is when total revenue = total costs
Normal profit is considered a cost so it is put in the cost of production.
Supernormal profit
aka abnormal profit or economic profit is the profit above normal.
This is when total revenue is greater than total costs.
Total revenue
is the total amount of money received from the sale of any given output sold by the business
It is the total quanitity sold (Q) X the average price (P) received.
Average revenue
show how much revenue there is per unit of output
= total revenue / output
Why is the average revenue curve the demand curve
If demand is elastic and price increases, the quantity demanded will fall.
The effect on total revenue depends on how elastic the demand is.
Marginal revenue definition and formula
refers to the increase in total revenue from increasing one output unit.
Change in revenue/ change in quantity
Total costs, fixed and variable costs
how much it costs to produce a given level of output.
Variable + Fixed
Average fixed costs
total fixed costs / quantity
Average variable costs
total variable costs / quantity
Marginal costs
is how much it costs to produce on extra unit of output
Why could there be a fall in marginal output
as a result of labour becoming less efficient and less productive.
Allocative efficiency
Where Demand = Supply. Society surplus Maximised.
Occurs when Price = Marginal cost
Productive efficiency
When a firm is operating at the lowest price on their AC curve. Full exploitations of economies of scale
Consumer analysis:
lower prices , high consumer surplus , full exploitations of EoS.
Producer Analysis
more production at lower AC, Higher Profit, Lower prices and greater market share.
X efficiency
Minimising waste.
Production on the AC curve
Consumer analysis:
lower prices, higher consumer surplus
Producer Analysis:
Lower cost, lower prices and market share
higher profit
Dynamic efficiency
Re-investment of LR supernormal profit into innovation, R&D
Consumer analysis:
New innovative products, lower prices over time, higher consumer surplus
Producer analysis:
LR profit max. , lower costs over time, retain market share, stay ahead of rivals
Efficiency
looks at how scarse resources are used.
is about society making optimal use of scarse resource to help satisfy the changing needs and wants of consumers.
Static efficiency
level of efficiency at one point in time
Market structures
is the number of firms competing for the demand of consumers, the nature of costs, the extent of baririers of entry and other factors.
Least competitive to most competitive industry
Monopoly, monopolisitic competition, Oligopoly, perfect competition.
Things to consider when considering competitiveness
Number of firms
Price maker of price taker
Perfect or imperfect information
Homogenous or non-homogenous goods/services
Barriers to entry/exit
A price maker vs price taker
price maker has influence as there are no perfect substitutes whereas a price taker has no influence
Homogenous goods vs non
Homogenous - All goods are of equal quality and identical having perfect substitutes
Non-Homogenous - all goods are of unequal quality having no perfect substitutes. Hetergenous.
Barriers to entry and exit
Entry - prevent firms from entering an industry
Exit - Prevent firms from leaving the industry
Objective of a Firm: Profit Maximisation
re-investment
Dividends for shareholders
Lower costs and lower prices for consumers
reward for entrepreneurship
Happens at MC = MR
Objective of firms: Profit satisficing
sacrificing profit to satisfy as many of the stakeholders as possible.
Objective of firms: Revenue Maximisation
MR = 0
Economies of Scale
Predatory pricing - driving out competition
Objectives of firms: Sales maximisation
AC = AR
EoS
limit prices
Flod the market
Assumptions for perfect competition
Many firms in the market because it is easy to enter and exit.
Many homogenous goods which means firms are price takers.
Perfect information meaning there are no industry secrets.
Firms are profit maximisers because they are restricted in pricing strategys.
What happens when a firm enters aperfect competition.
it causes supply to shift outwards. Equilibrium becomes lower price but lower quantity.
AR shifts downwards which causes supernormal profits to be cut until they are normal profit.
Charecteristics in Monopolistic competition
Many buyers & sellers
Slightly differentiated goods - firms are price makers, price elastic demand.
Low barriers to entry and exit.
Perfect information.
Non-price competition
Firms are profit motivated.
Large number of small firms
Advantages of Monopolistic competition markets
Firms are allocating inefficent in the short and long run (P>MC)
Since firms do not fully exploit their factors, there is excess capacity in the market. This makes firms productively inefficient.
Consumers get a wide variety of choic
It is a realistic model than perfect competition.
The supernomral profits produced in the short run might increase dynamic efficiency through investment.
Disadvantages of Monopolistic Competition
Int he long run, dynamic efficiency might be limited due to the lack of supernormal profits.
Firms aren’t as efficient as those in a perfectly competitive market. In a monopolistic competitive market, firms have X-efficiency, since they have little incentive to minimise their costs.
Charecterisitics of Monopoly
One seller dominates the market
- pure monopoly - 1 firm controls 100% share of the market
- monopoly power - 1 firms controls 25% of the market (legal monopoly)
Differentiated products - firm is a price maker
Higher barriers to entry
Imperfect information
Profit maximising firms
Efficiencies of Monopoly
They aren’t allocative efficient - charging higher prices, output is low.
They aren’t productively efficient since they aren’t on the lowest point of the AC curve.
They are X - efficient because they are producing above the AC curve because they don’t really need to when dominating the market.
Dynamically efficient - long run supernormal profits form the firm.
Pros of Monopoly
Dynamic efficiency - reinvests supernormal profit back into the business
Greater EoS - exploit this because of size.
Natural monopoly - gives desirable outcomes
Cross subsides - profit of one product and subsidise a loss making product.
