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EC1A5 - Microeconomics > Week 5 - Firm Behaviour: Pricing > Flashcards

Week 5 - Firm Behaviour: Pricing Flashcards

1
Q

What is an assumption about a firm?

A

They want to maximise profit

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2
Q

What happens to demand as the prices rise?

A

Demand falls

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3
Q

What happens to total revenue if the elasticity is <1 and price increases and quantity decreases?

A

Revenue increases

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4
Q

What happens to total revenue if prices increase and quantity decreases and elasticity is >1?

A

Total revenue decreases

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5
Q

What is average revenue?

A

Revenue per unit sold
AR=TR/Q

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6
Q

What is marginal revenue?

A

The change in revenue from producing one more unit.
The slope of TR at that point

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7
Q

Where is total revenue maximised?

A

Where marginal revenue is 0

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8
Q

What does it mean if marginal revenue is positive?

A

The total revenue is increased by increasing output (reducing price)

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9
Q

What does it mean if marginal revenue is negative?

A

The total revenue is increased by reducing output (increasing price)

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10
Q

What are average costs?

A

The average cost of producing each unit of output
AC=TC/Y

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11
Q

What are marginal costs?

A

The extra cost associated with producing one more unit of output.
This is the slope of the total cost function (derivative)

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12
Q

What is a fixed cost?

A

A cost that has to be paid whether or not you produce any output. E.G. fitting restaurant before you sell food.
TC (0)

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13
Q

What is a sunk cost?

A

Costs that once committed cannot be recovered.

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14
Q

What is it when a firm has decreasing economies of scale?

A

If a 1% increase in output leads to more than a 1% increase in total costs.

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15
Q

What is it when if a 1% increase in output leads to more than a 1% increase in total costs?

A

Decreasing economies of scale

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16
Q

What is it when a firm has increasing economies of scale?

A

a 1% increase in output leads to less than a 1% increase in total costs

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17
Q

What is it when a 1% increase in output leads to less than a 1% increase in total costs

A

Increasing economies of scale

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18
Q

What is it when a firm has constant returns to scale?

A

a 1% increase in output leads to a 1% increase in total costs

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19
Q

What is it when a 1% increase in output leads to a 1% increase in total costs

A

Constant returns to scale

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20
Q

What does decreasing returns to scale suggest?

A

That small firms have a cost advantage over larger firms

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21
Q

Draw a total costs diagram with annotations?

A

Axis
Slope
Line showing marginal cost as derivative

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22
Q

Draw two versions of average and marginal costs diagram?

A

Axis
One where MC is curved and one straight
Average cost /

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23
Q

What are the equivalents to this statement - The firm has increasing returns to scale?

A

The firm has MC<AC
The firm has declining average costs

24
Q

What are the equivalents to this statement - the firm has decreasing returns to scale?

A

The firm has MC>AC
The firm has increasing average costs

25
Q

What are the equivalents to this statement - the firm has constant returns to scale?

A

The firm has MC=AC
The firm has constant average costs

26
Q

Where is the profit maximising level of output?

A

Where MR=MC

27
Q

What is the shut down point on a diagram?

A

AC>P

28
Q

What is meant by the mark up?

A

The gap between price and marginal cost

29
Q

How does the extent of elasticity affect pricing by firms?

A

If demand is inelastic then prices will be higher
If demand is elastic then prices will be lower.

30
Q

What is the formula for the profit maximising price and what can we infer from it?

A

P=(E÷(E-1))MC
Can see that the lower is ε, the higher the price that is charged
If ε<1 then formula makes no sense
profit-maximization means firm can always increase profits by increasing prices

31
Q

What factors affect the demand curve?

A

Some things the firm controls itself:
-Advertising (adds to costs)
-Product quality (adds to costs)
-Economists do discuss these issues but we will not
The demand for the product from consumer
- From consumer demand
Market Structure:
-The number of other firms in the market (competitors)
-The prices they charge

32
Q

What is a monopoly?

A

One firm in the market

33
Q

What is an oligopoly?

A

When there are a small number of firms in the market but each firm thinks it has some influence over price

34
Q

What is perfect competition?

A

There are a large number of small firms in the market and each individual firm thinks it has no influence over price

35
Q

What are sources of monopolies?

A

Natural monopolies
Firm actions
Government created monopolies

36
Q

What are features of a natural monopoly?

A

If there are increasing returns to scale everywhere then largest firm has a competitive advantage and the market may end up with one firm
An example would be the distribution of water – would make no economic sense to have two sets of pipes delivering water
Natural monopolies tend to be in public ownership or heavily regulated by the government to prevent them abusing their market power
E.g. Ofwat in the UK water industry

37
Q

How may firm actions lead to be monopolies?

A

Firms would like to be monopolies as they will make more profits that way
One example would be through cornering the market in a good
Hedge fund Armajaro bought 7% of cocoa production, withheld it from the market and prices rose to highest level for 35 years
And Jamie Moakes’ attempt to corner the market in Ram-Man action figures ?????
Another common example is buying up rivals

38
Q

How may governments create monopolies?

A

Governments have competition and anti-trust laws to try to prevent firms acquiring too much market power
But governments can also create as well as prevent monopolies
E.g. Until 2005 only Royal Mail could deliver mail in UK no only daily mail can deliver parcels less than

39
Q

Why is demand more elastic in an oligopoly compared to a monopoly

A

Because consumers have more substitutes due to competing firms.
As demand curve more price-elastic with oligopoly mark-up of price over marginal cost will be lower than in monopoly

40
Q

What is monopolistic comeptition and key features?

A

a market structure where many companies offer similar but distinct products or services. Some key features of monopolistic competition include:
Product differentiation
Companies use branding, packaging, quality, and other features to make their products stand out from competitors.
Free entry and exit
There are few barriers to entry or exit, so new firms can enter the market and existing firms can leave if they experience losses.
Price-setting power
Firms have some control over prices, but they must also consider what their competitors are doing.
Imperfect information
Consumers may not have all the information they need about products and prices, which can allow firms to charge higher prices.
Monopolistic competition can lead to product innovation and variety, but it may also result in higher prices and lower efficiency than in perfect competition.

41
Q

How does a monopolistically competitive firm set prices on a diagram?

A

Firms produce where Marginal Revenue (MR) = Marginal Cost (MC).
Price (P) is set above Marginal Cost (MC).

42
Q

What determines the size of the markup in monopolistic competition?

A

The price elasticity of demand (ε):

Lower elasticity (less competition/substitutes) → Higher markup.
Higher elasticity (more competition/substitutes) → Lower markup.

43
Q

What happens in the long run in monopolistic competition?

A

Profits attract new firms, reducing demand for existing firms.
Losses lead to firm exit, increasing demand for remaining firms.
Long-run equilibrium: P = AC, Profits = 0 (but P > MC).

44
Q

How does the entry of new firms affect a firm’s demand curve?

A

Entry shifts the demand curve for individual firms leftward (lower demand).
This reduces profits until profits are zero in the long run.

45
Q

How does the exit of firms affect a firm’s demand curve?

A

Exit shifts the demand curve for remaining firms rightward (higher demand).
This raises profits until losses are eliminated.

46
Q

Why is monopolistic competition less efficient than perfect competition?

A

Price (P) > Marginal Cost (MC), so allocative efficiency is not achieved.
Firms operate at less than full capacity (excess capacity).

47
Q

What is “excess capacity” in monopolistic competition?

A

Firms do not produce at the minimum point on the Average Cost (AC) curve, meaning they could produce more at a lower cost.

48
Q

How do product differentiation and innovation play a role in monopolistic competition?

A

Firms compete by improving quality, branding, and features, which increases costs but attracts more consumers.

49
Q

What evidence supports the idea of monopolistic competition?

A

Price dispersion, even for homogeneous goods (e.g., supermarkets charging different prices for identical items)

50
Q

What is perfect competition?

A

This is the case where there are a very large number of firms in the market who are price-takers
If one firm tries to charge above the going price then no consumer will buy from them
If one firm charges even slightly less than the going price then get the whole market
Implies that demand curve is perfectly elastic at the market price

51
Q

What is the optimal decision of a perfectly competitive firm and draw this on a diagram?

A

For a perfectly competitive firm, MR=P
Profit-maximizing output is point where MR=MC but this is the situation where MC=P

52
Q

Why is perfect competition inconsistent with increasing returns to scale?

A

Large firms have cost advantages over small firms, contradicting the assumptions of perfect competition.
What this means is that perfect competition is inconsistent with increasing returns to scale
This is not surprising – with increasing returns, large firms have a cost advantage over small firms
Nature of technology influences market structure

53
Q

What is price discrimination?

A

Charging different prices to different customers based on willingness or ability to pay (e.g., student discounts).

54
Q

Where is the sum of consumer and producer surplus maximised in perfect competition?

A

Where P=MC

55
Q

What is maximised when P=MC in perfect competition?

A

the sum of consumer and producer surplus maximised

56
Q

Why are monopoly and oligopoly considered inefficient compared to perfect competition?

A

P > MC in these structures, leading to deadweight loss and reduced consumer/producer surplus.

57
Q

What are some public policies to address monopolies?

A

Increase competition (e.g., new entrants).
Regulate monopolies (e.g., price caps).
Turn monopolies into public enterprises.

EC1A5 - Microeconomics (6 decks)

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