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ECON TEST 3
Ch 9-11
| Question | Answer |
|---|---|
| Types of firms | Formal: Individual proprietorship, partnership, companies, CC's, trusts, public corporations Informal: street vendors, hawkings, smuggeling |
| Goal of the firm | Firms seek to maximise profit, cannot exist otherwise |
| Short vs Long run | Short: At least one fixed input, fixed plant capacity. Can only expand output by increasing qty of variable inputs Long: No fixed inputs & variable plant capacity size |
| Accounting cost | Includes explicit costs Refers to money firms pay for FOP |
| Economic cost (EC) | Includes explicit AND implicit costs Implicit cost = opportunity costs not reflected by monetary payments |
| Total/Accounting profit | TR-Explicit Costs To be a profit: TR> Explicit costs |
| Normal profit | Minimum profit just covering firms costs TR = TEC |
| Economic Profit | TR - TEC To be a profit: TR>TEC |
| Economic loss | TR<TEC |
| Abnormal/Supernormal profit | Profit> Implicit & Explicit costs |
| Production | Physical transformation of inputs (FOP + intermediate inputs) into outputs |
| Production function (PF) | relationship between inputs and outputs of a firm depends on technology |
| Fixed vs Variable inputs | Fixed: level of usage cannot be changed Variable: level of usage can be changed |
| Short run (SR) production function | One input must be fixed As variable input increases, output increases at increasing rate, then at a decreasing rate, until max, then it starts to decline |
| Law of diminishing marginal returns | When more of a variable input is combined with a fixed input in production, a point will be reached where MP then AP then TP will decline |
| Average product of variable input | average units produced per unit of variable input TP/ n |
| Marginal product of variable input | number of additional units produced per additional unit of variable input delta TP/ delta n |
| Total, average and marginal product of variable input | TP increases as long as MP is positive & decreases if MP id negative AP increases if MP is above AP, has max at AP=MP and then decreases |
| Fixed vs Variable Cost | Fixed cost: Remains constant irrespective of qty (overheads) Variable cost: Changes based on when total product changes (direct costs) |
| Total cost | TC = TFC+ TVC TC = AC * Q |
| Marginal cost | increase in total cost when one additional unit of output is produced MC = change TC / change Q |
| Average cost | AC = TC/Q AC = AVC + AFC AVC = TVC/Q AFC = TFC/Q |
| Total revenue | TR = P * Q |
| Average revenue | AR = TR/Q AR = P*Q / Q or TR/Q |
| Marginal revenue | MR = changes in TR / changes in Q |
| Total production | TP = AP * variable input (N) |
| Average production | AP = TP / variable input (N) |
| Marginal production | MP = change in TP / change in variable input (N) |
| FC & VC graph | Q on x-axis; costs on y-axis Difference between TVC and TC curve is the TFC |
| AC and MC graph | One MC to three AC curves AFC decreases as production increases AVC decreases until min then increases AC/ATC decreases until min then increase MC cuts AC and AVC at minimum |
| SR production curves & cost curves | Cost curves is determined by product curve Production curves sad faces & cost curves smiley faces (inversely shaped) MC is inversely MP AVC is inversely AP |
| Long run (LR) production & costs | Period long enough for firm to change qty of inputs in production process as well as process itself No fixed inputs or costs No law of diminishing returns Flexibility due to variable inputs |
| LR inputs depends on | Firm's characteristics Production processes Institutional environment |
| Returns to scale | Compare LR relationship between inputs & outputs The change in productivity due to proportionate increases of all inputs |
| Types of returns of scale | Constant returns to scale: % change in input = % change in outputs Increasing returns to scale: % change in input yields larger % change in output Deceasing returns to scale: % change in input yield smaller & change in output |
| Economies of scale | Because of increase in returns of scale Cost saving due to increase in production volume Decline in unit costs as output increases Ex. bulk buying |
| Diseconomies of scale | When unit costs increase as output increases Ex. Lack of control |
| Returns to scale vs Economies of scale | Returns to scale: input vs output Economies of scale: cost vs output |
| Economies of scope | Cost savings due to producing related goods in one firm Uses same capital incentive inputs for production of different products |
| LR Average cost curve (LRAC) | All inputs are variables, so curves can have different shapes Output per period(x) to Cost per unit (y) EOS: Sloping downwards Constant cost: Horizontal DOS: Sloping upwards |
| LR Average costs depends on | Prices of PF is given State of tech and quality of PF is given Firm chooses lowest cost combo of PF to produce @ each output level |
| Market structure continuum | Competition from Max to none Perfect comp > Monopolistic comp > Oligopoly > Monopoly |
| Eq conditions | 2 rules: Shut-down rule: Produce only when TR>=TVC & AR >=AVC Profit max: MR = MC or difference between where TR>TC is at its greatest |
| Perfect competition | Where none of individual market participants can influence price of the product - demand & supply determines prices Firms are price takers |
| Assumptions of perfect comp | 1. Large number of buyers & sellers 2. Homogenous or identical goods 3. No collusion 4.Free entry & exit from market 5. Full knowledge & info to all parties 6. No gov intervention 7. Full mobility of PF's (can move freely between markets) |
| Demand for perfect comp firm | Perfectly elastic demand (horizontal) since producer cannot influence market price Higher prices = no sales MR = D = AR = P (Mr Darp) |
| Profit max rule | MR = MC as long as MC is rising and above AVC Positive difference between TR & TC is at max |
| Marginal Revenue to Marginal Costs (MR vs MC) | MR>MC: Still making profit on last unit produced, adding to profit & expanding output MR = MC: Profit max MR<MC: Firm makes loss and output should decrease |
| Marginal cost curve | MR is horizontal line; MC is increasing line Intersect = profit max Left of point = profit increasing Right of point = profit decreasing |
| SR equilibrium positions perf comp | Economic profit Breaking even/Normal profit Economic loss |
| Economic profit | As long as AR>AC, firm earns econ profit MR = MC @ Q, where AR>AC Economic profit = square E1, AC@Q1, everything to the left |
| SR Equilibrium graphs | MC upwards sloping AC parabola (+) AR=MR horizontal line |
| Normal profit | Breaks even MR = MC = AC @ E |
| Economic loss | MR = MC at Q, where AC>AR Loss is square between E, AC@Q, and everything to the left |
| Should firm continue production @ economic loss | If P=AR is above AVC, continue production If P=AR is below AVC, shut down |
| Supply curve for perfectly comp firm | Rising section of MC curve, above min of AVC Shut down point: intersection of MC and AVC curves Break-even point: intersection of MC and AC curves |
| LR equilibium positions perf comp | PFs are variable Abnormal profit= more firms enter, market supply curve shifts right, decrease price & reduce profit Economic loss= firms exit market, market supply curve shifts left, price increase, normal profit LR all firms make normal profits |
| Monopoly | One seller of a good with no close substitutes Dominant seller & able to exert control over market Price setter Cause: barriers to entry |
| Barriers to entry | Something that prevents firm from entering an industry Ex: Economies of scale (Natural barrier) Patents Sole rights Licensing Import restrictions |
| Pure monopolies are rare: | Most have close substitutes |
| Monopolist profit maximization | MR=MC uses demand curve to find price that will induce customers to buy it |
| Monopolist revenue | AR = TR/Q = D Can only increase demand by lowering prices MR is not equal to AR - negative slope No Mr Darp!! P>MR=MC MR curve is under AR curve |
| Monopolist MR & TR | Positive MR - TR increases Zero MR - TR constant Negative MR - TR decreases |
| Elasticity of a monopoly | Monopolists produce in an elastic zone Positive MR: ep>1 (elastic) & TR increases Zero MR: ep=1 & TR constant Negative MR: ep<1 (inelastic) & TR decreases |
| SR equilibrium monopolies | Profit max @ MR=MC @ Q1 D-AC @ Q1 = profit Quantities lower than Q1: MR>MC Quantities higher than Q1: MR<MC |
| Monopoly supply curve | No supply curve Qty a monopoly supplies depends on demand curve Supply curves only work if price is a given & a monopoly is a price setter |
| Monopolist LR equilibrium | Since entry is blocked, economic profit can still be earned as long as demand is intact Firm will produce where MR = LRMC |
| Price discrimination | Charging different prices to different types of consumers for similar goods Firms must be a price setter Consumers/market must be independent (low-price consumes must not be able to sell for higher price) |
| 1st degree price discrimination | charging each customer the reservation price |
| 2nd degree pice discrimination | different prices for different qty of the same good or service |
| 3rd degree price discrimination | discrimination amongst buyers split markets and change different prices in each market |
| Natural monopoly | It is most cost efficient for one single firm to produce all output in a market Cost advantages - Economies of scale Common for public utilities AC is declining when D=AR reaches max |
| Natural monoply pricing | Ideal: MR=MC P=AC where AR=AC=D P=MC where AR=MC but it will make a loss since AC>AR Production efficiency where AC @ min, but there is no demand aka no qty. D<0 Gov can self-produce & compensate with taxes OR normal profit OR price discrimination |
| Monopolistic Competition | Large number of firms producing similar products with slight differences Firms face downward sloping D curve No barriers to entry or exit Firms have certain degree of monopolistic power since they are the only sellers of the brand ex. Woolworths |
| Non-price comp | Loyalty cards Longer business hours Greater advertising Sales |
| Oligopoly | Few (<10) firms dominate the market Barriers: Licensing, collusion or uncertainties) |
| Duopoly | Only 2 firms in the market |
| LR profits | Perf comp: Zero Monopolistic comp: Zero Oligopoly: Can be positive Monopoly: Can be positive |
| Social cost/ Deadweight loss of monopoly | Areas between D and S curve that was consumer and producer surplus, falls away & becomes deadweight |
| Monopoly misinterpretations | Able to charge any prices & highest price Guaranteed economic profit Has absolute economic power |
| Case against a monopoly | Lowe output & higher prices Little to no incentive for innovation Managerial inefficiency Politically powerful |
| Competition commision | Promote & maintain comp to achieve equity & efficiency in economy Investigative & enforcement agency |
| Competition tribunal | Accepts or rejects investigation & recommendations of Competition Commission |
| Competition Appeal Court | Considers appeals against Comp Tribunal |
Created by:
CARA.FAURIE
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