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Introduction To Business Economics > Week 3 - Modelling the firm & perfect competition > Flashcards

Week 3 - Modelling the firm & perfect competition Flashcards

1
Q

Two types of costs

A
  • Total costs
  • Margnal costs
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2
Q

Define total cost

A

Is the lowest way to make a given profit

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3
Q

Define marginal cost

A

Shows how much extra it costs to produce an additional unit of output

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4
Q

Two types of revenue

A
  • Total revenue = price x quantity sold
  • Marginal revenue - additional revenue of selling one extra unit
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5
Q

When does profit maximisation occur?

A

Marginal cost = marginal revenue

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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
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7
Q

3 general factors of production

A
  • Land
  • Capital - physical capital (machinery), human capital
  • Labour
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8
Q

What makes up costs of production?

A

Inputs - any good/service used in the production process

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9
Q

Difference between fixed and variable costs

A

Fixed costs cannot be varied but variable costs can be varied

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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
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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

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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
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13
Q

Define marginal product

A

The increase/decrease in total product from adopting on extra unit of input holding all other inputs constant

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14
Q

Marginal product curve

A

As MP increases it reaches a maximum at L* and then starts to decrease

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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
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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
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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
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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
Q

Define industry

A

The set of all firms making the same product

26
Q

Define market structure

A

A description of the behaviour of buyers and sellers in the market

27
Q

Different market structures

A
28
Q

Perfect completion assumptions (6)

A
  • 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
Q

Interpret perfect completion demand curves (5)

A
  • 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
Q

Formula for average revenue

A

AR = TR/Q

31
Q

How much output should a firm produce in a perfectly competitive market? (3)

A
  • 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
Q

How do you get industry supply curve in a perfect competitive market?

A

Simply horizontally sum the indivual supply curves

33
Q

Entry and exit in a perfect competition market (3)

A
  • 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
Q

Define abnormal profit

A

TR - TC

35
Q

Define normal profit

A

Ecom version of break even: TR =TC

36
Q

What happens in imperfect competition? (4)

A
  • 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
Q

Types of monopolies (2)

A
  • 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
Q

3 Key characteristics of monopolies

A
  • High capital costs
  • High entry barriers
  • Significant scale economies
39
Q

Monopoly assumptions (5)

A
  • 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
Q

Monopoly demand curve (AR & MR) (3)

A
  • 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
Q

How much should monopolies produce? (5)

A
  • 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
Q

How to measure monopoly power?

A

P - MC

43
Q

Interpret a Perfect competition vs monopoly curve

A
  • 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
Q

Arguments for monopoly (3)

A
  • 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

Introduction To Business Economics (9 decks)

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