unit 7 Flashcards
what do isoprofit curves show (6)
Isoprofit curves show all combinations of price and quantity that give the firm the same profit.
the shape depends on average costs for the firm
Isoporifit curves are steep when price is high and flatter when price is close to marginal cost
The slope of the isoprofit curve is given by:
- (Price - MC)/Q
Isoprofit curve is the indifference curve and its slope represents the marginal rate of substitution in profit creation, between selling more and charging more
what is the moat
something that separates the firm from its competitors and defends it against new entrants to the market
what does a firms profit depend on (4)
- customer base
- product differentiation
- competition
- innovation: keeps cost lower than competitors
what costs do firms face
- wages
- tax and government regualtion e.g. NMW
- production costs
how to find total costs
Total cost = unit cost x quantity
how to calculate total revenue
Total revenue = price x quantity
how to calculate total profit
Profit = total revenue – total costs
what is demand
how much potential consumers are willing to pay.
why is calculating using isoprofit curves not a good measure
Managers do not use isoprofit curves they usually do trial and error until they find their most profit maximising outcome
what is a profit function
shows the profit you would achieve if you chose to produce quantity Q and set the highest price that would enable you to sell that quantity
what is outsourcing
other firms choosing to be specialist skills rather than employing directly.
why may large firms be more profitable than small ones
- output is produced at a lower cost
- economies of scale
what does increasing output mean
it means increasing all inputs of production: workers, raw materials, machines, energy usage, factory premises, distribution trucks, advertising and packaging
why can large firms produce at a lower cost
Economies of scale in production: large scale production uses fewer inputs per unit of output. Economies of scale occur if doubling the amount of every input more than double output
Cost advantage: fixed costs such as advertising have a smaller effect on the cost per unit when output is high. Larger firms can purchase inputs at a lower cost because they have more bargaining power.
the different economic of scale in production (3)
Increasing output more than proportionally then the technology is said to exhibit increasing returns to scale in production or economies of scale
Increases output less than proportionally then the technology exhibits decreasing return to scale in production or diseconomies of scale
Increase output proportional then the technology exhibits constant returns to scale in production
what is a firms cost function
how much the firm’s production costs varies with its output level
what are fixed costs
they are fixed no matter how much the firm produces.
what are total costs
The sum of all the costs a firm incurs to produce its total output.
what are variable costs
if the firm increases production it will need to increase all the variable inputs thus increasing variable costs
how can costs per unit fall
they can fall if more output is produced and if there is fixed costs that do not depend on the number of units - they remain constant
formula for total costs
total costs = fixed costs + (cost per car)(quantity)
how to find average costs
total cost / total output quantity
what does the average cost represent
average costs is the marginal cost plus a share of the fixed costs this means the AC is greater then the marginal cost.
what are marginal costs
Marginal cost is the additional cost of producing one more unit of output
The cost increase when output increases by one unit is called marginal costs
Marginal costs are not always constant. A producer may have to increase storage in order to produce more cars. This increases MC
what do demand curves show
Demand curves show the trade-off the firm has to make between price and quantity
The demand curve is the feasible frontier and its slope represents the marginal rate of transformation of lower prices into greater quantity sold
slope of the dmeand curve is related to PED = -P/Q x 1/slope
what does price elasticity of demand show
Responsiveness of consumers to a price change.
Its defined as the percentage change in demand that would occur in response to 1% increase in price
elastic demand curve
- when a line is almost horizontal then demand is elastic
- this means responsiveness to price change is high
- demand is elastic if elasticity is higher than 1
- if demand is elastic the gain is greater then the loss when producing an extra unit so revenue rises
Inelastic demand curve
- when line is almost vertical then demand is inelastic
- not responsive to price changes
- if elasticity is less than one the demand is inelastic
- if demand is inelastic the loss outweighs the gain when producing one extra unit of the good: revenue falls
how to calculate elasticity of demand (2)
- % change in demand/%change in price
-P/Q x 1/slope
why is PED important for firms
- shows how much competition firms face
- high competition = lower prices which limits the firms ability to raise profits
what is marginal revenue
The change in revenue when output is increase by one unit
marginal revenue and PED
Marginal revenue is positive when demand is elastic. The firm can increase revenue by raising output because prices fall only a little
Marginal revenue is negative when demand is inelastic. The firm can increase revenue by decreasing output because prices rise a lot.
total profit calculation using
(Q x P) - (Q x Mc) - Fc
what happens when the price is equal to the firms marginal costs
economic profit is zero
average cost curve is also zero profit curve
at what point does a firm maximise its profits
isoprofit is tangent to the demand curve
marginal profit is zero
MRS = MRT
MC = MR
price markup is equal to the inverse of elasticity of its demand curve.
how can profit be seen on the price and quantity diagram
At a given point, profit is the area between that point and the zero profit curve, times the quantity
Recall that the AC curve is the zero-profit curve
We get back to this formula for profit:
Profit = Q (P-AC)
how to find marginal profit
MP = MR - MC
what can marginal revenue tell a firm
If MR > MC the firm could increase profit by raising Q
If MR < MC the marginal
profit is negative. Q should be reduced
Profit maximising Q is MR=MC
what is marginal revenue
the marginal revenue is always less than the price. The firm gains P when it sells an extra car but it loses revenue on the other cars as the price is lower than before.
MR curve is below the demand curve and slopes downwards.
why do people engage voluntarily in an economic interaction
because it makes them better off:
they obtain a surplus called economic rent.
what does joint surplus measure
The joint surplus is a measure of the gains from exchange or gains from trade
what does the surplus on each prodct porduced show
it shows the difference between the consumer’s WTP and the producer’s marginal cost.
is a price setting firms profit maximisation point pareto efficient?
no as not all potential gains have been exhaust: customers who won’t pay what the company asks but would still pay enough that the firm would profit
why does the firm not sell at a pareto efficient allocation
firm can only set a single price for all customers: setting different prices would be price discrimination
what is the lost surplus called
deadweight loss
consumer surplus, producer surplus, deadweight loss and outcome
Consumer surplus is the difference between the consumers WTP and what they actually pay
Producer surplus is the difference between the firm’s revenue and marginal cost. It does not account for fixed costs
Deadweight loss is the loss of potential total surplus. It is the sum of surplus losses of both consumers and producers
Firm chooses a level of output at which some again are not achieved through trade
what is a monopoly
a single seller. In most cases facing no competition and no threat of new rivals entering the market
what can increase a firms market power
Another firm producing substitutes goes out of business
Gaining property rights over its products
Strong brand loyalty for its products
innovating - differentiated products
advertising - attract customers and create brand loyalty
how can a firm differentiate its products (4)
- location
- products they select
- how they display them,
- additional service e.g. packaging and delivery
what happens if a firm has decrease average costs
the last unit of output is produced at a lower cost than the average for the previous units
the firm must set price to at least equal to average costs
this also limits competition by limiting the number of producers that can participate
what can competition policy do
- reduce market power
- encourage competition
how can a firm eliminate competition
- merge with other firms
- forming a cartel
