Introducing Supply Decisions Summary

Question 1

The theory of supply is..

Answer 1

the theory of how much output firms choose to produce

Question 2

There are three types of firm:

Answer 2

self-employed sole traders, partnerships and companies. Sole traders are the most numerous but are often very small. The large firms are companies.

Question 3

Companies are owned by..

Answer 3

their shareholders but run by the board of directors

Question 4

Shareholders have..

Answer 4

limited liability. Partners and sole traders have unlimited liability

Question 5

Costs should include..

Answer 5

opportunity costs of all resources used in production. Opportunity cost is the amount an input could obtain in its next highest paying use. In particular, economic costs include the cost of the owner’s time and effort in running a business.

Question 6

Economic costs also include..

Answer 6

the opportunity cost of financial capital used in the firm. Supernormal profit is the pure profit accruing to the owners after allowing for all these costs.

Question 7

Firms are assumed to aim to ..

Answer 7

maximize profits. Even though the firm is run by its managers, not its owners, profit maximization is a useful assumption in understanding the firm’s behaviour. Firms that make losses cannot continue in business indefinitely.

Question 8

In aiming to maximize profits, firms..

Answer 8

produce each output level as cheaply as possible. Profit maximization requires minimization of costs for each output level.

Question 9

Firms choose the optimal output level to..

Answer 9

maximize total economic profits. This decision can be described equivalently by examining marginal cost and marginal revenue. Marginal cost is the increase in total cost when one more unit is produced. Marginal revenueis the corresponding change in total revenue and depends on the demand curve for the firm’s product

Question 10

Profits are maximized at the ..

Answer 10

output at which marginal cost equals marginal revenue. If profits are negative at this output, the firm should close down if this reduces losses.

Question 11

An upward shift in the marginal cost curve ..

Answer 11

reduces output. An upward shift in the marginal revenue curve increases output.

Question 12

It is unnecessary for firms to calculate their..

Answer 12

marginal cost and marginal revenue curves. Setting MC equal to MR is merely a device that economists use to mimic the hunches of smart firms who correctly judge, by whatever means, the profit-maximizing level of output.