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Economics Micro > Micro part 5- Efficiency and Business Objectives > Flashcards

Micro part 5- Efficiency and Business Objectives Flashcards

1
Q

What is economic efficiency

A
  1. Where resources are allocated in so every consumer benefits and waste is minimised.
  2. There is allocative and productive efficiency
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2
Q

What is static efficiency

A
  1. Static efficiency refers to efficiency at one point in time (allocative and productive, resources are allocated efficiently)
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3
Q

What does dynamic refer to

A
  1. dynamic refers to new technology and increased productivity and how this increases efficient allocation of resources over time.
  2. dynamic is when the rate of innovation is at the optimum level causing LRAC to fall over time.
  3. It’s affected by short run factors like i.r. and confidence
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4
Q

What is productive efficiency

A
  1. Productive efficiency – when resources are used to give the maximum output at the lowest average cost. 2. When firms produce at the lowest point on the LRAC
  2. Can only exist when there’s technical efficiency
  3. For an economy it’s when producing on the PPF curve as there is no possibility of gaining any extra output if all firms are producing at lowest cost
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5
Q

How do monopolies relate to productive efficiency

A
  1. will be productively inefficient
  2. this is because monopolies restrict output to maximise profit so it operates at an output where AC is not lowest
  3. this means consumers take on higher costs creating higher prices
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6
Q

What is perfect competition in respect to productive efficiency

A
  1. firms will be trying to maximise their profits out of necessity to stay in the market.
  2. If they were not then a new entrant would enter the market, produce at the bottom of its AC curve, undercut the price of the original firm and that firm would be forced out of business
  3. this means firms will need to produce at the bottom of their AC curve (productively efficient) when in equilibrium
  4. this is because having to compete means there is strong incentive for firms to reduce waste and inefficiencies
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7
Q

What are problems with perfect competition in respect to AC cost/productive efficiency

A
  1. may not be in the s.r. since the firm profit maximises so may make ANP in the s.r.
  2. this means that allocative efficiency. output is greater than the ANP output
  3. so when making ANP in the s.r. then not productively efficient
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8
Q

What is allocative efficiency

A
  1. when the price consumers are willing to pay is equal to the cost to society of producing an additional unit. 2. Goods are produced in the best interests to society which maximises consumer welfare and utility. Where P = MC
  2. When resources are distributed to the g/s that consumers want
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9
Q

How do monopolies relate to allocative efficiency

A
  1. will be allocatively inefficient since P > MC
  2. because monopolies that profit maximise operate at an output where MC = MR
  3. this means consumers place greater value on the last unit bought tan the cost of producing that unit so the good is under-produced
  4. therefore consumer welfare will be reduced
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10
Q

What is perfect competition in respect to allocative efficiency

A
  1. perfect competition ensures the price mechanism works
  2. all firms are price takers (price is set by consumer preferences signalling and meaning resources are rationed)
  3. there is perfect information so firms can act on incentives to know whether to leave/enter a market
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11
Q

What does perfect competition in terms of allocative efficiency mean for consumer and producer surplus

A
  1. means that price is set to what consumers are willing to pay since the price mechanism ensures firms produce exactly what is demanded, meaning P=MC (allocative efficiency).
  2. This occurs because consumers are paying the price equal to the cost to society of producing an additional unit of the good (resources are allocated efficiently)
  3. consumer and producer surplus are maximised
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12
Q

What are problems with perfect competition in respect to allocative efficiency

A
  1. the MC to the firm may not take into account external costs/benefits that affect 3rd parties not involved in the economic transaction
  2. means MC of the firm is = MPC but due to externalities the MSC is > than MSB
  3. good is overproduced and overconsumed meaning industry may not be allocatively efficient
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13
Q

What is x-inefficiency

A
  1. X-inefficiency – occurs when a firm is not producing at the lowest possible cost for a given level of output. 2. Operating within its AC curve (not on boundary)
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14
Q

Why does x-inefficiency occur

A
  1. management is poor at controlling costs e.g. doesn’t get cheap prices for raw materials
  2. stakeholders within the firm are able to extract benefits greater than what the firm needs to pay e.g. managers taking higher bonuses
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15
Q

What is normal profit

A
  1. occurs when TR = TC.
  2. This means the extra revenue left after covering a firm’s money costs is equal to the opp. cost of the FoP that aren’t paid for.
  3. If extra revenue is less then it means the firm would have been better off putting the FoP to a different use. 4. It is the minimum profit to keep resources in their current use in l.r.
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16
Q

What is abnormal profit

A
  1. occurs when TR > TC.
  2. This means the revenue generated from using the FoP in this way is greater than could have been generated in any other way.
  3. Creates an incentive for firms to join the market
17
Q

What is divorce of ownership from control problem

A
  1. An example of the principal agent problem due to asymmetric information.
  2. The agent makes decisions for the principal, but the agent acts in their own interest
  3. In smaller firms the owners likely work for the company but in larger firms the owners are more likely to be shareholders and cannot exercise control over managers – creating a divorce from ownership
18
Q

Why are the shareholders and managers are unlikely to have the same objectives

A
  1. shareholders likely want to maximise s.r. profits as this increases the value of the shares
  2. a manager may have pay/bonuses linked to total sales or revenue so they may want to maximise this
19
Q

What can the divorce of ownership from control problem lead to

A
  1. This could lead to them satisficing (profits to the minimum acceptable level) as they still need some profits to stay in business and then work on other objectives
  2. This can give rise to x-inefficiencies where the firms costs per unit at a given output are above the LRAC curve
20
Q

How can owners tackle the divorce of ownership from control problem

A
  1. Owners can tackle this problem by making managers more accountable meaning they have to justify their actions and explain their future intentions.
  2. However this can be limited due to asymmetric information
21
Q

What is Profit maximisation

A
  1. occurs when MC = MR or the difference between TR and TC is greatest.
  2. If MC > MR then decrease output since it’s costing firms more to produce the last unit of output than it receives in revenue.
  3. If MC < MR then increase output because the revenue gained by increasing output is greater than the cost of producing it.
22
Q

What do neo-classical economists assume

A
  1. Neo-classical economists assume that firms aim to maximise s.r. profits
  2. implies firms are willing to supply in the s.r. even if they make a loss in the s.r. as long as price is higher than AVC
23
Q

What do Neo-Keynesian economists assume

A
  1. Neo-Keynesian economists assume that firms aim to maximise l.r. profits
  2. this is due to cost plus pricing techniques where the price is calculated by calculating ATC of operating at full capacity.
  3. These means price and therefore profit is set based upon l.r. costs

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24
Q

What does s.r. profit maximisation imply

A
  1. s.r. profit maximisation implies firms adjust price/output depending on changes in the market, but frequent price adjustments may damage their position in the market
25
Q

What effects could different price adjustments have

A
  1. price reductions could lead to a price war
  2. price increases may be seen as profiteering causing consumers to switch other brands as they feel they can receive better quality
  3. price changes incur costs because firms have to frequently change prices
  4. therefore firms will want to maintain stable prices based on l.r. costs
26
Q

Why might it be prefered to keep prices above market

A
  1. may prefer to keep prices above market if believe price changes may have a permanent effect on prices and therefore l.r. profits
27
Q

What profit do firms need to keep operating in the l.r and what happens if it can’t

A
  1. . Firms need to make normal profit to keep operating in the l.r.
  2. If it can’t then will close because its revenue is not covering all the costs.
28
Q

What will allow firms to continue running in the short run and what will cause them to close immediately

A
  1. . In the s.r. a loss-making firm has fixed costs to pay no matter the revenue so may continue to operate in the s.r.
  2. if TR > TVC or AR > AVC then continue to operate in the s.r. since the extra revenue can contribute towards paying fixed costs
  3. if TR < TVC then will close immediately
29
Q

What is the relevance of profit maximisation for businesses

A
  1. important in perfectly competitive because if don’t profit maximise then forced out of business
  2. important in oligopolistic/monopoly as it’s a source of funds for innovation
30
Q

What are the benefits of profit maximisation

A
  1. more profit can be used to create dynamic efficiency through investment in R&D
  2. profits can be used to pay higher wages to workers (not be equally shared if there is monopsony power)
  3. greater profits can allow firms to negotiate low i.r. loan deals since they are perceived to be of lower risk due to their profitability. This can create internal economies of scale. This can reduce costs
  4. reduce chance of aggressive takeover from another firm
31
Q

What is the extent to which profit maximise will depend on market structure

A
  1. If concentration ratio is high then profit maximise to survive
  2. whether they want to long run or short run profit maximise
  3. monopolies may not as if there is a high contestability then don’t want to incentivise other firms to join the industry so instead may choose to sales revenue maximise to increase output

Economics Micro (19 decks)

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