Business objectives

Question 1

Define firm

Answer 1

An organisation that brings together factors of production in order to produce output

Question 2

What is normal profit

Answer 2

the return needed for a firm to stay in the market in the long run. Equal to opportunity cost

Question 3

What is supernormal profit

Answer 3

profits above normal profit (includes opportunity cost)

Question 4

When does profit maximisation occur

Answer 4

MC=MR. Long-run ovjective

Question 5

Where does sales revenue maximisation occur

Answer 5

MR=0. Production is increased to a point where additional sales would reduce overall revenue because to make an extra sale the price of all such goods would have to be reduced

Question 6

Where does sales volume maximisation occur

Answer 6

AC=AR. A higher level of sales would cause AR

Question 7

Maximise growth

Answer 7

Increase market share and the size of the firm. Cutting prices below cost will lead to a loss in short run but may lead to even higher long run profits due to increased brand recognition and increased economies of scale. Higher sales may make it easier to borrow money.

Question 8

What does conventional theory of the firm assume

Answer 8

Businesses have enough information, market power and motivation to set their own prices, that maximise their total profit. We assume firms profit maximise and stay in the market making SNP.

Question 9

Profit maximisation realistic assumptions

Answer 9

Information: know costs and revenue so can calculate MC=MR.

Single product businesses: may only make a single product

Question 10

Profit maximisation unrealistic assumptions

Answer 10

Imperfect information: Hard to pinpoint MC=MR as can not accurately calculate MR and MC. Prices are on basis of ‘estimated demand’.
Multi-product businesses: have a lot of information to handle and must keep track of changing preferences.
Ignores time: to capture long-run market, in the short-run requires not to produce MC=MR to capture market share

Question 11

Order of speed of growth (fastest-slowest)

Answer 11

growth max, sales volume max, sales revenue max, profit max

Question 12

Order of profits (greatest to lowest)

Answer 12

Profit max(+), sales revenue max(+), sales volume max (zero profit), growth max(negative profit)

Question 13

What is the principle agent problem

Answer 13

Arises because of information asymmetry between managers and owners , meaning that managers may not be viewed by shareholders as maximising profit, if objectives of managers are different to shareholders the managers may not achieve the same objective.

Question 14

utility maximisation

Answer 14

Managers may enjoy status of running a large team, having a large office, company car

Question 15

Profit satisficing

Answer 15

Lazy managers mey want to have an easier time at work so acept lower profits that are still acceptable to shareholders

Question 16

Social welfare

Answer 16

the frim exsists to benefit wider society, may donate % of profit

Question 17

Corporate social responsibility (CSR)

Answer 17

businesses doing/sponsoring charity work or encouraging employees to volunteer

Question 18

How does a firm choose an objective

Answer 18

It reflects the objectives of the owners. E.g. shareholders usually profit maximise whereas government may want to increase social welfare

Question 19

How do owners minimise principle agent problem

Answer 19

By aligning incentives of managers with owners with performance related pay, so managers want to maximise profit

Question 20

Adavantage of utility maximisation

Answer 20

+ ‘traffics of power’ may be necessary to recruit most productive and effective employees

Question 21

Disadvantage of utility maximisation

Answer 21

‘Trappings of power’ may be expensive and unecessary

Question 22

Adavantage of social welfare

Answer 22

Popular with customers, increasing sales

Question 23

Disadvantages of social welfare

Answer 23

High opportunity cost of not earning more profit

Question 24

Advantage of CSR

Answer 24

Popular with customers, happier and more productive employees

Question 25

Disadvantage of CSR

Answer 25

Expensive and divert attention form more profitable endeavours

Question 26

Advantage of profit satisficing

Answer 26

Prevent unscrupulous behaviour that can lead to new legislation being imposed

Question 27

Disadvantage of profit satisficing

Answer 27

Lower profits than possible

Question 28

What does the objective the firm choose depend on

Answer 28

The extent to which principle agent problem exsists, the larger the problem the more objectives diverge

Question 29

The extent to which social welfare benefits form over profit max depends on

Answer 29

Preferences of target market, the more strongly target market feel about cause the greater the benefit

Question 30

What is total average costs

Answer 30

Total cost divided by the quantity produced often called unit cost

Question 31

What is marginal costs

Answer 31

Cost of producing an additional unit of output

Question 32

Why is the short run different for different businesses

Answer 32

because of the marginal cost curve decrease at first as the output increases

Question 33

Why must MC cross AC at the lowest point on AC

Answer 33

1. When MC below AC, cost of one more unit brings AC down. 2. MC above AC, cost of one more unit increases AC 3. So when MC=AC. MC is not changing AC

Question 34

Define short-run

Answer 34

Period of rime over which a firm is free to vary its input of one factor of production (labour), but faces fixed inputs of the other factors of production

Question 35

Define long-run

Answer 35

Period over which the firm is able to vary the inputs of all its factors of production

Question 36

What is the law of diminishing marginal utility

Answer 36

If a firm increases its inputs of one factor of production while holding inputs of other factors of production fixed, eventually the firm will get diminishing marginal returns from the variable factors

Question 37

What are sunk costs

Answer 37

Costs incurred by a firm that cannot be recovered if the firm ceases trading e.g. advertising

Question 38

What does a short run average cost curve show

Answer 38

relationship between the volume of production and costs under the assumption that the quantity of capital and other inputs are fixed - to change the output, the firm has to vary the amount of labour

Question 39

What does the position of cost curve depend on

Answer 39

quantity of capital and ,in the long-run, this (along with labour, land and enterprise) can change

Question 40

in the long run how can the SRAC be shifted

Answer 40

changes in the amount of capital available. Increasing returns to capital cause SRAC to shift down as output increases. The locus of SRAC minima are taken to describe LRAC curve

Question 41

Why is the law of diminishing returns not important

Answer 41

small firms may not need to consider it, as a firm with a small number of staff or a small amount of capital may only see increasing returns to scale

Question 42

Why is the law of diminishing returns important

Answer 42

1. Explains why no infinite profits can be made | 2. Results in there being a level of production at which profits are maximised (profit maximisation)

Question 43

Define economies of scale

Answer 43

Occur for a firm when an increase in the scale of production leads to production at lower long-run AC

Question 44

What are internal economies of scale

Answer 44

economies of scale that arise from the expansion of a firm

Question 45

What are external economies of scale

Answer 45

economies of scale that arise from the expansion of the industry in which a firm is operating

Question 46

What are technical efficiency

Answer 46

attaining the maximum possible output from a given set of inputs

Question 47

What are cost efficiency

Answer 47

the appropriate combination of inputs of factors of production, given the relative prices of those factors

Question 48

Technical economies of scale (internal)

Answer 48

production line methods, specialised equipment, specialisation to a greater extent in larger firms, containerisation

Question 49

Purchasing economies of scale (internal)

Answer 49

bulk buying, larger firms need large quantities of raw materials so can negotiate discounts

Question 50

Managerial economies of scale (internal)

Answer 50

specialist managers (finance, production, customer service) gain expertise and experience leading to better decisions, number of managers needed increase more slowly than output, lowering AC

Question 51

Financial economies of scale (internal)

Answer 51

larger firms can borrow money at a lower interest rate as banks pass on their own economies of scale and lending is less risky

Question 52

Risk bearing economies of scale (internal)

Answer 52

Larger firms can diversify into different product areas, confident that some will succeed - only large firms can afford to take the risk

Question 53

Marketing economies of scale (internal)

Answer 53

advertising is a fixed cost, so more output is produced, the cost to advertise per unit falls. Larger firms benefit from brand awareness so need to advertise less

Question 54

More skilled labour economies of scale (external)

Answer 54

A larger industry has a larger pool of skilles labour so a firm can hire labour more cost effectively because spending on training will be lower. e.g. silicon valley Local colleges may start to offer qualifications needed by big local employers, reducing firms' training costs e.g. worcester bosch

Question 55

More regional capital (external)

Answer 55

large companies relocating may lead to improvements in road networks or local public transport. Improvements in local infrastructure, firms that have similar activities may share resources e.g. research facilities. Suppliers may locate near to large firms to reduce transport costs

Question 56

Economies of scale that are not dependent on specialization

Answer 56

risk bearing, financial economies, managerial economies, marketing economies

Question 57

Analysis of internal economies of scale

Answer 57

As firms grow and sales increase, it can bulk buy factor inputs at a lower AC - and so the firm benefits from purchasing economies of scale

Question 58

Analysis of external economies of scale

Answer 58

When a firm expands and becomes large enough, it can benefit from regional capital by working with local educators to design training courses for potential employees. This leads to more highly skilled workers for the firms at lower cost

Question 59

Causes of economies of scale

Answer 59

Larger industries tend to have more scope for economies of scale, firms can benefit from more economies of scale, and there is more scope to benefit from each. (There are no large hairdressing firms but several large oil firms)

Question 60

Significance of economies of scale

Answer 60

The existence of economies of scale and, over time, the more successful utilisation thereof, is a major part of why standards of living continue to rise

Question 61

What are diseconomies of scale

Answer 61

occur for a firm when an increase in the scale of production leads to production at higher LRAC

Question 62

What are internal diseconomies of scale

Answer 62

diseconomies of scale that arise from the expansion of a firm

Question 63

What are external economies of scale

Answer 63

diseconomies of scale that arise from the expansion of the industry in which a firm is operating

Question 64

Control diseconomies of scale (internal)

Answer 64

managers find it harder to control what workers do due to the complexity of monitoring large numbers of workers (similar to the principle-agent problem)

Question 65

Coordination diseconomies of scale (internal)

Answer 65

Managers find it harder to coordinate the activities of workers and between teams due to the complexity of communicating with large numbers of people. May take place over several countries and time zones, increasing the difficulty.

Question 66

Cooperation diseconomies of scale (internal)

Answer 66

Workers in large firms may develop a sense of alienation and loss of morale if they do not feel listened to, leading to wastage of factor inputs and higher costs. May be caused by office politics

Question 67

Factor inputs diseconomies (external)

Answer 67

As the industry grows from a single, or many, growing firms, the increased demand, ceteris paribus, leads to increased prices of factor inputs e.g. Li shortage for electric cars

Question 68

Exhausted local supplies diseconomies (external)

Answer 68

Bulk buying may exhaust nearby, local supplies which leads to increased transport costs of additional supplies bough from further away e.g. tech workers

Question 69

Analysis of diseconomies of scale

Answer 69

When a firm expands coordination diseconomies can occur because managers find communicating more complex

Question 70

Causes of diseconomies of scale

Answer 70

different types of market experience diseconomies of scale at different points. The greater the proportion of a firm's costs that are variable costs, the more quickly a firm may hit decreasing returns to scale

Question 71

Significance of diseconomies of scale

Answer 71

The more quickly incumbent firms experience diseconomies of scale, the more potential there is for new firms to enter the market and complete

Question 72

What is total revenue

Answer 72

revenue received by a firm from its sales of a good or service it is the quantity sold, multiplied by the price - assuming there is one type of product selling at one price

Question 73

what is average revenue

Answer 73

received by a firm per unit of output; TR/Q0. AR=P0. Assuming there is one type of product selling at one price

Question 74

What is marginal revenue

Answer 74

additional revenue received by a firm if it sells an additional unit of output

Question 75

Where is TR shown on a graph

Answer 75

area of the rectangle on a graph inside the equilibrium (QxP)

Question 76

Why does D=AR

Answer 76

because AR that a firm receives for a given number of sales is equal to the price that leads to those sales

Question 77

Why is MR steeper than the demand curve

Answer 77

because MR=0 when PED on the demand curve is unitary. MR becomes negative when the price increases lead to lower TR; PED is inelastic

Question 78

Why does AR=MR

Answer 78

because each extra unit sold brings the same revenue as all the previous sales. AR is constant so TR increases proportionately with sales, this is true for firms that are price takers

Question 79

Features of price takers

Answer 79

They have no market power, when setting prices; they accept the market clearing price because there are a large number of firms all making the same good (among other features)

Question 80

Define accounting profit

Answer 80

TR-TC

Question 81

Define economic cost

Answer 81

TC+ opportunity cost

Question 82

What do firms need to stay in the market

Answer 82

make enough profit to cover the opportunity cost. If accounting profit is lower than opportunity cost, the firm would be better off using their resources elsewhere; they would leave the market.

Question 83

Why does profit maximisation occur at MC=MR

Answer 83

If MR from the next sale is greater than MC of that sale, the next sale is contributing to profits so should be made. If MR from the next sale is less than the MC of that sale, the next sale makes a loss so should not be made. Production should therefore be increased until the MR of production equals the MC of production to maximise profits.