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Economics PPLE > Unit 7 - The Firm and its Customers > Flashcards

Unit 7 - The Firm and its Customers Flashcards

1
Q

how does the firm choose prices for its products?

A
  • depends on the demand it faces and its production costs
  • Firms can influence both consumer demand and costs through innovation or advertising as well
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2
Q

Demand curve

A

how quantity demanded varies with changes in price

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3
Q

formula for total costs

A

Total costs = unit cost x quantity

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4
Q

formula for total revenue

A

Total revenue = price x quantity

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5
Q

formula for profit

A

Profit = total revenue - total costs
Profit = (price - cost) x quantity

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6
Q

Isoprofit curve

A
  • joins the points that give the same level of total profit
  • The firm is indifferent between combinations of price and quantity that give the same profit
  • The isoprofit curves nearer to the origin correspond to lower levels of profit
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7
Q

what determines profit maximisation

A

To achieve a high profit, you would like both price and quantity to be as high as possible, but you are constrained by the demand curve.

The demand curve determines what is feasible.

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8
Q

profit function

A

it shows the profit achieved for every quantity, set at the highest price the demand function allows you to set

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9
Q

explanation of the graph that determines profits

A
  • The slope of the isoprofit curve - the MRS - the trade-off you are willing to make between P and Q
  • You would be willing to substitute a high price for a lower quantity if you obtained the same profit
  • The slope of the demand curve - the MRT - the rate at which the demand curve allows you to transform Q into P
  • The two trade-offs balance at the profit-maximizing choice of P and Q
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10
Q

why do large firms produce output at a lower cost per unit

A
  • Technological advantages
  • Cost advantages
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11
Q

Economies of scale or increasing returns

A
  • the technological advantages of large-scale production - when a firm grows beyond a size when it’s more profitable to produce larger quantities

–> Results from specialization
–> Marketing economies of scale - buying in bulk
–> Financial economies of scale - it’s easier to get financial loans when a firm growns beyond a certain size

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12
Q

Constant return to scale

A

output increases proportionally to the increase in input

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13
Q

Diseconomies of scale or decreasing returns to scale

A
  • if inputs are increased by a given proportion, output increases less than proportionally
  • Communication issues within a big firm
  • Increasing production requires more than a proportional increase in supervision and management
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14
Q

fixed cost

A

costs independent of the level of the firm’s output

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15
Q

network economies of scale

A

People are more likely to buy products when they know other people are also using them

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16
Q

opportunity cost of capital

A
  • the return on investment they would receive if they invested their money in something else
  • Part of the cost of producing cars is the amount that has to be paid out to shareholders to cover the opportunity cost of capital
  • for them to continue to invest to produce cars
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17
Q

Average cost curve

A

Average cost = total cost/quantity

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18
Q

Marginal Cost

A
  • the additional cost of producing one more unit of output - it is the slope of the cost function
  • MC = change in cost/change in quantity
  • To draw the MC curve - calculate the MC at every point on the cost function
  • When AC = MC - AC is flat - the slope of AC is 0
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19
Q

differentiated product

A

“Differentiated product” refers to products that can remain competitive despite being put against competing products that are very similar. “

We expect a firm selling a differentiated product to face a downward-sloping demand curve.

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20
Q

how to calculate the profit in isoprofit curves

A

Profit = total revenue - total costs = P(Q) - C(Q)

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21
Q

Normal profits

A

Cost function includes the opportunity cost of capital, which is referred to as normal profits

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22
Q

Economic profits

A

is the additional profit above the minimum return required by shareholders

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23
Q

Profit

A
  • Profit is the number of units of output multiplied by the profit per unit, which is the difference between the price and the average cost
  • Profit = total revenue - total costs = P(Q) - C(Q)
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24
Q

Profit per Unit

A
  • Profit = Q(P - AC)
  • Profit per unit - the difference between the price and the average cost - P - AC
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25
Q

demand curve

A
  • The product demand curve is a relationship that tells you the number of items they will buy at each possible price
  • Each consumer has a willingness to pay, which depends on how much customer values it; a consumer will buy a car if the price is less than or equal to his or her WTP
  • If P is lower there are a larger number of consumers willing to buy, so the demand is higher
  • We expect demand curves to slope downward (not necessarily straight though)
  • The demand curve determines the feasible set of combinations of P and Q, so in order to find the profit-maximising point we will draw the isoprofit curves, and look for the point of tangency
26
Q

slope of the isoprofit curve

A

will depend on the shape of the ac curve

27
Q

the zero economic profit curve

A

P=AC at all points of the curve

If the price received by the firm causes it to produce at a quantity where price equals average cost, which occurs at the minimum point of the AC curve, then the firm earns zero profits.

28
Q

isoprofit curves - when do they slope downward/upward

A

Isoprofit curves slope downward at points where P > MC

Isoprofit curves slope upward where P < MC

29
Q

profit margin

A
  • The difference between the price and the marginal cost is called the profit margin, at any point on the isoprofit curve the slope is given by:
  • Profit margin = P - MC
  • Slope of isoprofit curve = - profit margin / quantity
  • The profit margin is positive so the slope is negative, vice versa
30
Q

when does a firm maximise profits

A

The firm maximises profit at the tangency point where the slope of the demand curve is equal to the slope of the isoprofit curve, so that the two trade-offs are in balance

At the profit maximisation point, MRT = MRS

31
Q

constrained optimization

A

A decision-maker chooses the values of one or more variables - to achieve an objective subject to a constraint that determines the feasible set

32
Q

Marginal revenue

A

MR = change in revenue/change in quantity

  • When P is high and Q is low, MR is high: the gain from selling one more car is much greater than the total loss on the small number of other cars.
  • As we move down the demand curve P falls (so the gain on the last car gets smaller), and Q rises (so the total loss on the other cars is bigger), so MR falls and eventually becomes negative.
33
Q

Using marginal revenue to find the point of profit maximization

A

Marginal profit = MR - MC

MR>MC - marginal profit is positive, so profit increases with Q

MR<MC - marginal profit is negative, profit decreases with Q

Profit max point - where MC = MR

Indicated by the max point of the profit curve

34
Q

consumer surplus

A

The consumer surplus is a measure of the benefits of participation in the market for consumers.

35
Q

producer surplus

A

The producer surplus is closely related to the firm’s profit, but it is not quite the same thing.

Producer surplus = Revenue - MC

Producer surplus is the difference between the firm’s revenue and the marginal costs of every unit, but it doesn’t allow for the fixed costs

36
Q

gains from trade

A

Gains from exchange (or trade) is the total surplus for the parties involved in an economic interaction (sum of economic rent)

37
Q

Total surplus

A

The total surplus arising from trade in this market, for the firm and consumers together, is the sum of consumer and producer surplus.

Total surplus = producer surplus + consumer surplus

38
Q

determining profit with surplus and fixed cost

A

The profit is the producer surplus minus fixed costs.
Profit = producer surplus - fixed costs

39
Q

deadweight loss

A
  • the loss of potential surplus
  • Under perfect price discrimination - the deadweight loss would disappear - the firm would capture the entire surplus - no consumer surplus
  • This scenario is pareto efficient
40
Q

pareto efficiency

A

A pareto-efficient allocation - where D curve intersects the MC curve - there are no more consumers willing to pay more than the P at the pareto-efficient allocation

Higher consumer surplus - consumers are better off

Total surplus is higher

41
Q

The elasticity of demand

A

Profit maximization depends on the elasticity of demand

42
Q

law of demand

A

quantity demanded falls when price increases

43
Q

PED

A
  • measure of the responsiveness of consumers to a price change

PED = - % change in q demanded/% change in price

PED = infinity - demand curve is flat - perfectly elastic
PED = 0 - demand curve is vertical - perfectly inelastic
PED = 1 - x=y - unitary elastic
PED>1 - elastic demand
PED<1 - inelastic demand

  • Profit margin is related to the elasticity of demand
44
Q

Elastic demand

A

PED>1

  • Elastic —> for an elastic demand a percentage change in price would cause a higher percentage change in quantity demanded
  • curve is flatter
45
Q

Inealstic demand

A

PED<1 - inelastic demand

  • Inelastic —> for an inelastic demand a percentage change in price would cause a lower percentage change in quantity demanded —> meaning you can play with the prices because people will still purchase
  • The lower the elasticity of demand - the more the firm will raise P above MC to achieve a high profit margin
  • curve is steeper
46
Q

zero-economic-profit curve

A

the combinations of price and quantity for which economic profit is equal to zero— because the price is just equal to the average cost at each quantity.

47
Q

markup

A

profit margin as a proportion of the price

Inelastic demand - high-profit markup

48
Q

Using demand elasticities in government policy

A

The effect of a tax on a good will depend on the elasticity of demand for the good

If demand is highly elastic - the tax will cause a large reduction in sales - reducing potential tax revenue

A government wishing to raise tax revenue, has to tax products with inelastic demand

49
Q

monopoly

A
  • one seller on the market
  • the firm can set a price greater than the MC
50
Q

market failure

A
  • when markets allocate resources in a Pareto-inefficient wat

-Deadweight loss - consequence of market failure - the unexploited gains from trade

51
Q

Monopoly rents

A

economic profits over and above its production costs

52
Q

firm with few subsidies

A

low elasticity of demand - the firm has market power

53
Q

subsidies

A

a sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low.

54
Q

How is the firm is able to influence the demand curve to increase profits

A

By changing the selection of products - product differentiation; technological innovation
Through advertising - create brand loyalty

55
Q

Natural monopoly

A

AC is lower when operating on a large-scale - when a single firm can supply the whole market at lower AC than multiple firms, then the industry is a natural monopoly

56
Q

reciprocity

A

the practice of exchanging things with others for mutual benefit, especially privileges granted by one country or organization to another.

57
Q

Economies of scale

A

a proportionate saving in costs gained by an increased level of production

–> for a bakery a the costs per croissaint are lower the more croissant the bakery bakes

–> relevant for specialisation

58
Q

Economies of scope

A

a proportionate saving in costs gained by producing two or more distinct goods when the cost of doing so i less than that of producing separately

–> for a bakery the costs per croissant are lower the more cheese sticks the bakery sells

59
Q

Comparative advantage

A
  • who can produce the greatest advantage giving up the other good

–> who can produce more of a good; who is better at it

60
Q

substitution effect

A

substitute free time for work because you earn more → incentive to work more because the opportunity cost of free time is higher

61
Q

income effect

A

budget constraint shifts outwards effect of additional income with no change in the opportunity cost

Economics PPLE (8 decks)

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