Week 3 - Modelling the firm & perfect competition Flashcards
1
Q
Two types of costs
A
- Total costs
- Margnal costs
2
Q
Define total cost
A
Is the lowest way to make a given profit
3
Q
Define marginal cost
A
Shows how much extra it costs to produce an additional unit of output
4
Q
Two types of revenue
A
- Total revenue = price x quantity sold
- Marginal revenue - additional revenue of selling one extra unit
5
Q
When does profit maximisation occur?
A
Marginal cost = marginal revenue
6
Q
Interpret revenue and cost curves
A
- When MR > MC, we produce more output
- When MR < MC, we produce less output
- When MR = MC profit is maximised
7
Q
3 general factors of production
A
- Land
- Capital - physical capital (machinery), human capital
- Labour
8
Q
What makes up costs of production?
A
Inputs - any good/service used in the production process
9
Q
Difference between fixed and variable costs
A
Fixed costs cannot be varied but variable costs can be varied
10
Q
How are costs associated through short run and long run? (2)
A
- In the long run all costs are variable e.g labour costs
- Land and capital are usually fixed costs
11
Q
Short run assumption about factors of production
A
In SR we assume factors of production are fixed and there is at least one variable factor
12
Q
How can a firm increase/decrease output in the short run? And the impact (3)
A
- Changing the quality of the variable factor
- However, if you increase the number of workers, firms often encounter diminishing marginal product
- If you keep adding a variable factor to a fixed factor the productivity of the additional units of the variable factors begins to fall
13
Q
Define marginal product
A
The increase/decrease in total product from adopting on extra unit of input holding all other inputs constant
14
Q
Marginal product curve
A
As MP increases it reaches a maximum at L* and then starts to decrease
15
Q
Marginal cost curve (2)
A
- This curve mirror the marginal product (MP) curve
- MC decreases at first, but then it reaches a maximum at Q* then it increases
16
Q
Optimal output in the SR (3)
A
- Firms maximise profit in the SR where MC = MR
- If Q
- If Q>Q*, then the firm should produce less
17
Q
Perfect competition Market assumptions (5)
A
- The firm is the profit taker (MR is determined by the market)
- MR is constant
- P = MR = MC
- Firm produces at Q and maximises profit
- ATC = AVC + AFC
18
Q
Interpret Short run graph in perfect competition
A
- Here the firm should continue to produce
- If P > AVC, the firm is covering AVC and some of AFC
19
Q
Interpret a Shut-down rule diagram in perfect competition (2)
A
- AVC can’t be covered so firm must shut down
- If P < AVC, the firm is not covering AVC or any AFC
20
Q
Costs & supply in LR in perfect competition (4)
A
- Profit maximised in LR is when MC = MR
- If P < LRAC the firm should shut-down
- As the firm increases output, LRAC falls
- Point B is the minimum efficient scale which is output where all scale economies are achieved
21
Q
Why does LRAC fall as firm increases output? (3)
A
- Fixed costs are spread over a large number of produced units
- Specialisation - become better a producing goods more effectively
- A larger scale takes advantage of better physical capital
22
Q
Interpret a LR and SR AC curve (3)
A
- Each factory has a capacity and is designed for a given level of output (Q)
- In the LR new factories or production lines can be added hencce numerous SRAS
- Each SRAS corresponds to a different optimal level of output
23
Q
Supply decisions in Short run summary:
- Profit maximising point
- shut down point
A
- Profit maximising output is where: MR= SRMC
- Shuf down temporarily when: P < SRAVC
24
Q
Supply decisions in Long run summary:
- Profit maximising point
- shut down point
A
- Profit maximising when: MR = LRMC
- Shut down permanently when: P < LRAC
25
Define industry
The set of all firms making the same product
26
Define market structure
A description of the behaviour of buyers and sellers in the market
27
Different market structures
28
Perfect completion assumptions (6)
* Each firm produces a homogenous product (exactly the same)
* There are an infinite no.of potential buyers and sellers in the industry
* There is perfect information available to all buyers and sellers
* There are no entry or exit barriers to prospective firms or current firms in the industry
* Each firm sets out to profit maximise (MC=MR)
* Firm is a price taker - the actions of buyers and sellers has no impact on the market price
29
Interpret perfect completion demand curves (5)
* The interaction of market demand and supply sets the market price (P1)
* The firm then 'takes' the price, creating the elastic firm demand curve (AR1)
* The firm produces Q1 units, at point A, where MC = MR
* Here, P \> AVC and more importantly, P \> ATC
* The blue shaded area represents abnormal profit
30
Formula for average revenue
AR = TR/Q
31
How much output should a firm produce in a perfectly competitive market? (3)
* Firm maximises profit at MC = MR
* In a competitive market (only) when demand is perfectly elastic P = MR (price taker)
* If you sell a unit for £10 every time p, your MR = £10
32
How do you get industry supply curve in a perfect competitive market?
Simply horizontally sum the indivual supply curves
33
Entry and exit in a perfect competition market (3)
* The market price become depressed (P1 to P2)
* Firms are forced to reduce prices (price takers), AR = MR shifts (AR1 to AR2)
* At point B, abnormal profit no longer exists and firms make normal profit
34
Define abnormal profit
TR - TC
35
Define normal profit
Ecom version of break even: TR =TC
36
What happens in imperfect competition? (4)
* The market does not satisfy the conditions for perfect competition
* Indivudal firms or consumers have some influence on the market price
* Subsequently firms face a downward sloping demand curve
* Firms therefore have market power and are seen as price-setters (price-makers)
37
Types of monopolies (2)
* Pure monopoly - the sole supplier of the industry's output
* Natural monopoly - arises where the largest supplier in an industry, often the first supplier in amendment, has an overwhelming cost advantage over other actual and potential customers
38
3 Key characteristics of monopolies
* High capital costs
* High entry barriers
* Significant scale economies
39
Monopoly assumptions (5)
* One seller of the good/service
* No substitute goods available
* High barriers to entry
* Profit max: MC = MR
* Faces a downward sloping demand curve, market demand curve = firm demand curve
40
Monopoly demand curve (AR & MR) (3)
* As there is only one firm in the market this is also the market demand curve
* MR does not equal AR so firm must reduce price to sell more units
* Eventually MR tends to 0 and then becomes negative
41
How much should monopolies produce? (5)
* Proit max: MC = MR
* Monopolist produces at Q and changes P
* As P is above ATC, the monopolist makes abnormal profit
* Monopoly: P \> MC
* Perfect competition: P = MC
42
How to measure monopoly power?
P - MC
43
Interpret a Perfect competition vs monopoly curve
* D is the market demand curve
* Under PC, D(AR) = MR
* LRS is the MC curve (supply curve)
* Monopoly - produce less (Qm) and change more (Pm)
* Perfect competition - produce more (Qc) and charge less (Pc)
44
Arguments for monopoly (3)
* Making abnormal profits may allow better R&D
* Patents are another form of giving a monopoly - can encourage investment
* Economies of scale - lower costs passed on to consumers
