Unit 3 Business Economics & Economic Efficiency

Question 0

Allocative efficiency

Answer 0

Where resources are used to produce what consumers actually want to buy I. E. Where resources are allocated such that no consumer could be made better off without another consumer becoming worse off (Pareto so optimality).

Question 1

Productive efficiency

Answer 1

Where goods are produced at the minimum possible average cost.

Question 2

Dynamic efficiency

Answer 2

Where development of new products and policy of new technology is rapid other time.

Question 3

X-Inefficiency

Answer 3

The rise in average costs when a firm with monopoly power gets complacent about facing limited competition in a market.

Question 4

Fixed cost (FC)

Answer 4

A cost which is independent of output in the short run (e.g rent).

Question 5

Variable cost (VC)

Answer 5

A cost which is related to output produced in the short run (e.g raw materials - as output increases, so more materials need paying for).

Question 6

Marginal cost (MG)

Answer 6

The addition to total cost from producing an extra unit of output.

Question 7

Law of Diminishing (Marginal) returns

Answer 7

The fall in marginal product as additional units of the variable factor of production are added to the fixed factors.

Question 8

Average cost (AC)

Answer 8

The cost per unit of output.

Question 9

Average revenue (AR)

Answer 9

The revenue per unit of output.

Question 10

Marginal Revenue (MR)

Answer 10

The addition to total revenue from producing an extra unit of output.

Question 11

Normal profit (NP)

Answer 11

The minimum (accounting) profit which the entrepreneur needs to stay in long-term production.

Question 12

Super Normal Profit (SNP)

Answer 12

Profit in excess of normal profit (a.k.a abnormal profit - acts as a signal for new firms to enter the market).

Question 13

Short run (SR)

Answer 13

Period of time when at least one factor of production is fixed.

Question 14

Long run (LR)

Answer 14

Period of time when all factors of production are variable.

Question 15

Shut-down point

Answer 15

Where revenue covers variable costs only (with no contribution to fixed costs).

Question 16

Economy of scale

Answer 16

The gains in efficiency (fall in unit costs) from expanding the scale of production (I. E from expanding all factors of production in the long run).

( 5 types: technical (area-volume relationships, indivisibility, large specialist machinery etc), bulk buying, financial, risk-spreading, specialisation.

Question 17

Diseconomies of scale

Answer 17

The fall in efficiency (rise in unit costs) from expanding the scale of production (I. E from expanding all factors of production in the long run).

Occurs when a firm becomes harder to manage (needing more costly bureaucracy), worker morale weakens and/or intrafirm transport costs rise.

Question 18

Profit maximisation

Answer 18

Price and output are chosen to maximise supernormal profit.

Question 19

Revenue maximisation

Answer 19

Price and output are chosen to maximise total revenue.

Question 20

Sales Maximisation

Answer 20

Price and output are chosen to maximise sales volume (subject to earning a minimum profit).

Question 21

Satisficing

Answer 21

Managers aim to make a satisfactory profit (anything at or above a minimum level).

Question 22

Perfect competition

Answer 22

Market structure where there are very many (an infinite number of) buyers and sellers such that no individual can buy or sell at any price other than the ‘going price’.

Question 23

Monopoly

Answer 23

A single seller in the market or industry. (Competition Commission criteria: firm with over 25% of market share)

Question 24

Monopsony

Answer 24

Single buyer in a market.

Question 25

Concentration ratio

Answer 25

The market share of the largest (specified) number of firms in an industry.

Question 26

Monopolistic competition

Answer 26

An industry with a large number of sellers each selling goods which are close but not perfect substitutes.

Form of imperfect competition.

Question 27

Oligopoly

Answer 27

A market dominated by a few firms. ( usually recognised by a high ratio e.g over 50% for a 5 firm concentration ratio)

Question 28

Price discrimination

Answer 28

Where a firm sells identical products at different prices to different buyers for reasons other than differing cost of supply.

Question 29

Game theory

Answer 29

Theories where one participant’s behaviour is directly dependent on another’s behaviour.

Used to model oligopoly E. G in a 2×2 option pay-off matrix where each firm can choose ‘price rise’ or ‘price cuts’ leading to possible cooperative equilibrium (collusion to raise price) or competitive equilibriums (price war).

Question 30

Collusion

Answer 30

Where firms agree not to compete on price.

Question 31

Price leadership

Answer 31

When a dominant firm sets a price for rivals to copy through an implicit collusive understanding.

All are aware if smaller firms fail to follow a price rise, the price leader can force them out of business in a price war.

Question 32

Kinked demand curve

Answer 32

Demand curve facing and oligopolist which is relatively priced elastic if price is raised but relatively priced inelastic if price is reduced.

Question 33

Predatory pricing

Answer 33

A short run strategy where a firm undercuts rivals on price to below costs (likely to initiate a price war).

Question 34

Limit pricing

Answer 34

Where existing firms attempt to prevent new entry by pricing low so that new entrants will not make normal profits.

Question 35

Cost plus pricing

Answer 35

Where firms set price at average cost plus a profit margin, without explicit reference to estimated demand curve.

Question 36

Non price competition

Answer 36

Where firms attempt to make more profit without cutting price.

Methods include: 1: branding (promoting a product to appeal to a certain consumer sub-group so they will remain customer loyal even after price rises), 2: research and development (designing improvements to existing products), 3: product diversification.

Question 37

Contestable market

Answer 37

An industry where there are no significant barriers to entry or exit (no sunk costs).

Question 38

Sunk cost

Answer 38

A cost which cannot be recouped on exiting the industry.

E.g advertising, anything which cannot be sold second hand (old promotional literature etc)

Question 39

Merger

Answer 39

Joining of two previously separate firms into one.
4 types: 1:horizontal (same industry, same stage of production), 2: vertical (same industry, different stage of production) a) Backward (by supplier), b) Forward (e.g. buy retailer), 3: lateral (related industries), 4: conglomerate (unrelated industries) = source of external growth (quicker than growing internally by reinvesting profits etc… but raises competition issues, especially when horizontal).

Question 40

Competition policy

Answer 40

Government efforts to ensure balms and do not exploit monopoly power.

UK firms are subject to investigation by UK Competition Commission and EU body (who can investigate monopolies – firms over 25% market share, mergers and anti–competitive practices like collusion).

Question 41

Market for corporate control

Answer 41

The competition for control of companies through takeovers.

Question 42

Privatisation

Answer 42

Broad definition: the increased use of market forces in markets previously dominated by state planning.
Narrow definition: the sale of state owned industries to the private sector.

First major privatisation was BT in 1984; 10 years saw most nationalised industries sold off; copied abroad; a supply-side policy since it increases competition.

Question 43

Regulator

Answer 43

Government agent responsible for setting maximum prices and insuring against abuse of monopoly power by those companies who face limited competition in product markets.

Question 44

Regulatory capture

Answer 44

Where a regulated firm achieves softer regulation.

Firm persuades the regulator that its costs are higher than they are, or that prospects for profitability are lower than they really are; the regulator may tend to forget his job is to protect consumers by simulating competitive pressure because he is overexposed to the firm’s problems.