Firms and Decisions Flashcards
(114 cards)
1
Q
What is Production?
A
Production is the process of using resources (also known as Factors of Production (FOP) - CELL: Capital, Entrepreneurship, Land, and Labour) to produce goods or services.
The production process ends when the output is sold, i.e. distribution (such as
wholesale and retail trade) is also considered to be part of the production
process. Production ends with consumption.
2
Q
What is an industry?
A
An industry is made up of firms producing similar goods and services.
3
Q
What is a plant?
A
A plant is a collection of factors of production a particular location where production takes place.
4
Q
What is a firm?
A
A firm is a decision-making unit by the entrepreneur who combines and organises the factors of production - land, labour, capital to produce a good or service
5
Q
Note:
- “Costs” in economics typically refer to the cost of production by firms.
Students should not confuse ‘costs’ with ‘price’.
- ‘Price’ typically refers to the equilibrium price per unit producers charge
consumers for a good and/or service in a market.
A
.
6
Q
What are Fixed Factors?
A
Fixed factors are factors of
production that cannot be
increased within a given time
period. (e.g. land, factories, shop spaces, and machines)
7
Q
What are Variable Factors?
A
Variable factors are factors
of production that can be
increased within a given time
period. (e.g. labour and raw materials)
8
Q
What is a Short Run?
A
Short run is a time period in which there is at least one fixed factor.
9
Q
What is a Long Run?
A
Long run is a time period where all the factors of production are variable.
10
Q
What does Total Fixed Costs (TFC) refer to?
A
Total Fixed Costs refers to costs that do not vary with output.
11
Q
What is Total Variable Costs (TVC) ?
A
Total Variable Costs refers to costs that vary directly with output.
12
Q
Formula for Total Cost (TC)
A
TC = TFC + TVC
13
Q
Formula for Average Fixed Cost (AFC)
A
AFC = Total Fixed Cost/Quantity
14
Q
Formula for Average Variable Cost (AVC)
A
AVC = Total Variable Cost/ Quantity
15
Q
Formula for Marginal Cost (MC)
A
MC = Change in Total Cost/ Change in Quantity
16
Q
What is Economies of Scale?
A
Economies of Scale are cost savings that a firm enjoys when it increases its scale of production or when the whole industry expands, leading to a decrease in the cost per unit of production (or average cost).
17
Q
What is Internal Economies of Scale?
A
Internal Economies of Scale (iEOS) are cost savings that a firm enjoys
when it increases its scale of production, leading to a decrease in the cost per
unit of production.
18
Q
What is External Economies of Scale?
A
External Economies of Scale are cost savings that a firm enjoys when the industry expands, leading to a decrease in the cost per unit of production.
19
Q
Important:
Economies of Scale and Diseconomies of Scale are long run cost concepts
pertaining to per unit cost / average costs of production - NOT the total cost
of production!
A
.
20
Q
What is Internal Diseconomies of Scale?
A
Internal diseconomies of scale are cost dis-savings that a firm faces when it increases its scale of production, leading to an increase in the cost per unit of production
21
Q
What are the sources of Internal Diseconomies of Scale?
A
Coordination problems
Fall in Motivation
Technical issues in the production process
22
Q
What are External Diseconomies of Scale?
A
External Diseconomies of Scale are cost dis-savings that a firm faces when the industry expands, leading to an increase in the cost per unit of production
23
Q
What is Minimum Efficient Scale (MES)?
A
Minimum Efficient Scale is the lowest output at which the firm can produce at so that long run average costs are minimised. It is represented by the lowest point on the long run average cost curve.
24
Q
What is Total Revenue?
A
Total Revenue of a firm is the total amount of money received by a firm from the sale of a given level of output (per time period)
25
What is the formula for Total Revenue (TR)?
TR = Price x Quantity
26
What is Average Revenue?
Average Revenue is the amount of money that a firm receives per unit of output sold over a given time period.
27
What is Marginal Revenue?
Marginal Revenue is additional revenue gained by selling one more unit of output per period of time.
28
What is the formula for Average Revenue (AR)?
AR = TR/Q = Price (P)
29
What is the formula for Marginal Revenue (MR)?
Marginal Revenue (MR) = Change in TR/Change in Q
30
Why does a price-setting firm face a downward sloping demand curve?
This is because price-setting firms cannot control BOTH price and quantity, but instead control either price or quantity.
31
What is Explicit Costs?
Explicit Costs refer to the actual "out of pocket" expenditure incurred by a firm to buy or hire factors of production. They involve money payment or financial outlay made by the firm
32
What is Implicit Costs?
Implicit Costs do not involve any direct payment of money to a third party but involve a sacrifice by the firm.
33
What is Normal Profit?
When AR=AC (TR=TC). The firm will earn accounting profit but it barely covers explicit and implicit costs to an economist
Normal Profit is the minimum amount of profit a firm must earn to stay in the industry in the long run
34
What is Supernormal Profit?
When AR-AC (or TR-TC)>0 . It is profit in excess of normal profit
35
What is Subnormal profit?
When AR-AC (or TR-TC)<0. Subnormal profit, or a loss, is made.
Subnormal profits in the long run would incentivise existing firms to exit the industry in the long run
36
What are the difficulties in maximising profit?
Lack of Information
Changing environment
Government regulation
37
What are the alternative objectives to profit maximisation firms may choose to achieve?
Revenue Maximisation
Profit Satisficing
Market Share Dominance
Environmental concerns
38
What is Predatory Pricing?
Where a firm sets its prices below average cost to drive competitors out of business (based on the objective of 'market share dominance')
39
What is Barriers to Entry?
Barriers to entry are conditions that impede the entry of new firms into an industry
40
What is Contestability?
Contestability refers to the ability of new rival firms to enter an industry to compete with existing firms
41
What are the types of barriers to entry?
1.Cost Barriers
2.Access to key resources/factor inputs
3.Financial Barriers
4.Legal Barriers
5.Anti competitive strategies of incumbent firms
6.Information Barriers
7.Product differentiation and brand loyalty
42
What are the Anti-competitive Price Strategies?
1. Limit Pricing (acts as a deterrence BEFORE entry of new firms)
2.Predatory Pricing
43
What are the Anti-competitive Non-price Strategies?
Firms may mount massive advertising campaigns or introduce attractive after-sales service, until the loyalty to the brand is so strong that the brand becomes synonymous with the product
44
What is Market Share?
Market Share is the proportion of the total market output produced by each firm
45
What is Market Power?
Market Power is the extent to which a firm(s) can influence a product's market price?
46
What are the nature of products?
-Homogenous (product sold is indistinguishable between firms)
-Unique (the product has no substitutes)
-Differentiated (has many close substitutes but are different in some ways from others, eg. bubbletea)
47
What are the types of Market Structures?
-Perfectly competitive markets
-Imperfectly competitive markets
48
What does Perfectly Competitive Market refer to?
Perfectly Competitive Markets refer to markets where free competition exists (Perfect Competition)
49
What does Imperfectly Competitive Market refer to?
Imperfectly Competitive Markets refer to markets with restriction to free competition (Monopolistic competition, Oligopoly & Monopoly)
50
What does Perfect Competition refer to?
Perfect Competition refers to a market structure where there are many firms, none of which is large; where there is freedom of entry into the industry; where all firms produce an identical product; and where all firms are price takers
51
Why are Perfectly Competitive firms price takers?
Perfectly Competitive firms are price takers with no market power because:
-There are no barriers to entry and hence there are a large number of small firms with insignificant market share; and
-They sell homogenous products that are perfect substitutes
52
What is a Monopoly?
Monopoly refers to a market structure where there is only one firm in the industry
There is no competition since there is only one seller of a unique good with no close substitutes, and there are very high barriers to entry
53
What is a Natural Monopoly?
A Natural Monopoly is defined as an industry where long run average costs fall throughout the range of market demand.
54
What does Oligopoly refer to?
An Oligopoly refers to a market dominated by a few large firms with high barriers to entry. Products may be differentiated or homogenous.
55
What is Market Concentration Ratio?
The Market Concentration Ratio measures the combined market share of the top "n" firms in the industry
56
What is the n-firm concentration ratio formula?
(output of "n" largest firms/Total industry output) x 100%
57
Note: The characteristics of 'mutual independence' and 'high rival consciousness' are unique features of oligopolistic firms and must be highlighted when analysing firms in such markets.
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58
Note: large firms, eg. oligopolistic firms, may refrain from price competition as it may be ineffective due to mutual interdependence and rival consciousness. This is because a fall in price would cause the firm to face a price inelastic demand curve as rival firms would match the price cuts. Therefore, the quantity demanded for its product would rise less than proportionately, causing the total revenue to fall.
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59
What is Monopolistic Competition?
A monopolistic competitive market structure is one where there are many firms and freedom of entry into the industry, but where each firm produces a differentiated product and thus has some control over its price.
60
What are the characteristics of Monopolistic Competition?
-Low barriers to entry
-Large number of small firms
-Differentiated product
61
What are the Non-Price strategies firms can pursue to increase profits?
-Growth
-Diversification
-Shut down
-Innovation and R&D
-Marketing
-Collusion with other firms
62
What are the Price strategies for firms to increase profit?
-Price competition
-Price discrimination
63
What is Internal Growth?
The firm increases its size by producing more of its existing products or extending its range of products.
64
What is External Growth?
The firm grows when it joins another firm to form a larger firm. This means that the growth is much faster than internal expansion. This can be achieved through (i) merger and (ii) acquisition
65
What is a Merger?
This occurs when two firms mutually agreed to merge to form a single and larger organisation
66
What is acquisition?
Acquisitions or takeovers occur when a firm's management makes a direct offer to the owners or shareholders of another firm to acquire a controlling interest in the new entity
67
What are the different forms of Mergers and Acquisitions (M&A)?
-Vertical Integration
-Horizontal Integration
-Conglomerate Integration
68
What is Vertical Integration?
Vertical Integration occurs when firms at different stages of a good's production process join together to form a larger firm.
69
What is Horizontal Integration?
Horizontal Integration occurs when firms at the same stage of the production process and in the same industry merge.
70
What is Conglomerate Integration?
Conglomerate merger takes place when firms from totally different industries merge. These firms do not share similar products or services. The objective of this type of merger is greater diversification to reduce risks.
71
What is Diversification?
Diversification enables a firm to achieve new sources of revenue and spread its risks as losses incurred from one product can be offset by profits earned from another
72
What is Economies of Scope?
Economies of Scope refer to the cost reductions when a firm increases its range of products
73
What is Forward Integration?
Involves the firm merging with another firm at the succeeding stage of production (moving closer to the retail outlet or consumers)
74
What is Backward Integration?
Occurs when a firm merges with another firm at the previous stage of production (moving up the supply chain). This creates a stable supply of inputs and ensures consistent quality in the final product
75
Important:
In the short run, whether the firm continues production or shuts down
immediately depends on whether its total revenue (TR) can cover at least its
total variable cost (TVC) or average revenue (AR) can cover the average
variable cost (AVC).
* The firm will continue to produce as long as TR covers TVC or AR covers
the AVC.
* The firm will shut down if the TR is less than the TVC or AR
.
76
Note:
‘Shutdown’ as a strategy is a used to minimise losses rather than to increase
profits. It applies to both smaller and larger firms.
As such, we will not be using the FEAST framework or smaller vs larger-firm
framework to analyse this strategy.
.
77
What is Marketing?
Marketing refers to efforts taken by the firm to promote its product
78
What is Informative Advertising?
Informative advertising refers to where a firm informs consumers about the prices of its products, the tangible characteristics of its products, or the location and conditions of sale
79
What is Persuasive Advertising?
Persuasive advertising tries to convince customers that the advertised product is superior to its alternatives in terms of quality or desirability
80
What is Salience Bias?
Salience Bias refers to the tendency for people to focus on more prominent information over other less prominent but equally relevant pieces of information
81
What is Loss Aversion?
Loss Aversion refers to the tendency for people to prefer avoiding a loss over making an equivalent or greater gain
82
What is Sunk Cost Fallacy?
Sunk Cost Fallacy arises when a person's decision is affected by fixed rather than marginal costs.
83
What is Collusion?
Collusion refers to the situation where firms in a market cooperate to jointly fix prices or output
84
Note:
In a cartel, all firms charge the same price (unless individual firms ‘cheat’) but
may not be producing the same output level.
For example, Saudi Arabia, the de facto leader of OPEC, produces almost a
quarter of the cartel output, whereas Algeria produces only 1%.
.
85
What is a Cartel?
Firms in formal collusive agreements form a Cartel.
86
What is Tacit Collusion?
Firms may collude tacitly by watching each other's prices and keeping theirs similar
87
Note:
In the price leadership model, all firms charge the same price (based on the
price leader’s profit-maximising price) but may not produce the same output
level.
The price set by the price leader may not allow other firms in the industry to
maximise profits because it focuses on its own cost and revenue conditions
(i.e. to maximise its profits). However, overall industry profits are likely to be
higher than if firms chose to compete.
.
88
What are the factors that may cause a fall in the profit-maximisation price
-Fall in variable costs that cause a fall in MC(and AC) (e.g. fall in wages/raw materials)
-Fall in demand for the firm's product (e.g. fall in consumers' income causing demand for normal goods to fall/ increase in the number of competing firms in the market) ; and
-Firms that are increasing output and reaping more iEOS ->outward shift of DD and MR-> downward movement along the AC
89
Note: Change in fixed costs, e.g. rent, R&D costs and advertising costs, will
not change MC because these costs do not vary with output and MC is
affected by a change in costs due to a change in output. A change in fixed
costs should only change AC and not MC. Therefore, the profit-maximisation
price should not change.
.
90
What is Price Discrimination?
Price Discrimination occurs when a producer sells the same commodity to different buyers at different prices for reasons not associated with differences in cost
91
What are the three conditions necessary for successful price discrimination?
a) Price elasticities of Demand differ for different markets;
b) The markets can be effectively segmented; and
c) There is limited resale (or seepage between markets)
92
What are the three different types of Price Discrimination?
i) First-Degree Price Discrimination
ii) Second-Degree Price Discrimination and
iii) Third-Degree Price Discrimination
93
What is Third-Degree Price Discrimination?
Third-degree price determination refers to efforts taken by a firm to:
- raise its price in the market where demand is price inelastic; and
- lower its price in the market where demand is price elastic.
This enables the firm to earn higher revenue and hence higher profits from both markets than charging a single price
94
What is Market Power?
Market Power refers to the ability of firms to raise prices and profits above the perfectly competitive level.
Typically the firm will gain at the expense of consumers
95
What are the strategies for Market Power?
1. Growth (* Increase in market share → increase DD for firm’s product
* Fall in number of rival firms → increase DD & reduce PED of firm’s product)
2. Diversification
(* Diversification allows for growth and expansion→ Increase in market share → increase DD for the firm’s product
* Diversification increases the uniqueness of a
firm’s product offerings in terms of product
range →reducing PED)
3. Innovation
(* Targets consumers’ tastes & preferences → stimulates higher demand for firms’ products
* Increase uniqueness of firm’s product →reduce PED)
4.Marketing
(* Targets consumers’ tastes & preferences → stimulates higher demand for firms’ products
* Increase perceived uniqueness of firm’s
product → reduce PED)
5. Collusion
(* Reduces the level of competition in the market/allows cartels to act like a big monopoly
→ Increase in market share → increase DD for firm’s product)
6. Price Competition
(* Reduces the level of market competition in the long term → Increase in market share in future→ increase DD for firm’s product in future)
7. Price Discrimination
(* Allows firms to set higher prices in the sub-
market where PED<1)
96
What are the three criterias to analyse the impact on society's welfare?
Allocative efficiency
Productive efficiency
Dynamic efficiency
97
What is Allocative Efficiency?
Allocative efficiency can be defined as the output where society's welfare is maximised.
At the firm level, this is achieved where Price (P)= Marginal Cost (MC)
98
What is Productive Efficiency?
Productive efficiency is achieved when a given level of output is produced at the lowest cost.
99
What is X-inefficiency?
X-inefficiency usually occurs when a firm acquires so much market power that it is no longer threatened by potential competitors or new entrants, resulting in complacency and reducing its incentive to keep costs to the lowest.
100
What is Dynamic Efficiency?
Dynamic efficiency is achieved when firms invest in technology so that productivity and product quality will improve over time
101
What is Dynamic efficiency dependent on?
-Incentive of firms to innovate (depends on the level of competition & contestability in the market); and
-Ability to innovate (depends on types of AR and profits of the firm)
102
Note:
Key terms to use when dealing with Dynamic efficiency:
-greater/reduced ABILITY to innovate
-greater/reduced INCENTIVE to innovate
main terms are ABILITY and INCENTIVE when it comes to what leads to the dynamic efficiency
greater ability/incentive to innovate -> greater dynamic efficiency
Reduced ability/incentive to innovate -> lower dynamic efficiency
103
What are the three criteria and respective impacts on consumer's welfare?
1)Consumer Surplus- Firm's decision that results in lower prices and higher output will result in greater consumer surplus and benefit consumers
2)Product Variety- Firm's decision that provide greater product variety will benefit consumers (consumer choice)
3)Product Quality- Firm's decision that improves product quality will benefit consumers
104
What are the three ways in which the government can address market dominance?
1) Anti-Trust (Anti-Monopoly) Laws
2)Takeover/Nationalisation
3) Government Regulatory Pricing
105
What are Anti-Trust (Anti-Monopoly) Laws?
Anti-trust or Anti-monopoly laws promote or maintain market competition by regulating anti-competitive conduct by companies.
106
What are the strengths of Anti-trust laws? (FEAST diagram)
[Effectiveness] If the penalties are harsh, such measures should be able to secure compliance from firms
[Feasibility] Less expensive to implement than nationalisation. Not feasible to use ant-trust laws against natural monopolies as it is difficult to inject competition in the market
[Time] Can be quicker to implement than other policies , e.g. nationalisation that takes time and require parliamentary approval
107
What are the limitations of Anti-trust laws? (FEAST diagram)
[Feasibility] The problem with using legislation or some form of government regulation is that enforcement of such laws or regulations may be difficult and expensive. Constant monitoring is needed, which can translate into high costs for the government
[Effectiveness] In addition, for the law to be effective, the penalties for breaking the law must be sufficiently harsh.
In the case of anti-trust laws, it may be very difficult to prove that firms actually collude or engage in anti-competitive actions
[Side-effects] These laws may also prevent the benefits of mergers from being enjoyed, where cost savings due to internal economies of scale could lead to lower prices for consumers.
108
What are the strengths of Nationalisation? (FEAST diagram)
[Feasibility] Only if the government owns and operates the firm would the government indeed be aware of the actual marginal cost and be able to charge a price equal to marginal cost to promote allocative efficiency.
[Effectiveness] In the case of natural monopolies, it is not possible to introduce competition and hence the only way to ensure social welfare is for the government to nationalise it.
[Side-effects] Specific key industries under public ownership may result in higher
investment than if they were under
private ownership. E.g. many
governments invested heavily in the
state-owned railway system. This
resulted in fast, efficient transport
services, with generally obvious
benefits to commuters and the
economy. A good case for discussion
is the proposal by some economists to
nationalise the MRT train services in
Singapore. The under-investment in
the maintenance of the rail system
under private ownership has resulted
in the frequent breakdown of the
services in recent years.
109
Strengths and limitations of Nationalisation on pg 113-114 on Firms and Decisions pdf (FEAST diagram)
.
110
What are the alternative objectives of a firm other than profit maximising?
1) Revenue maximising
2) Profit satisficing
3) Market share dominance
4) Environmental concern
111
What is the Marginalist Principle?
Based on the Marginalist Principle, the rational firm that aims to
maximise profit should produce at output Qe where MC=MR and MC is
rising.
(DOUBLE CHECK FOR ACCURACY JUST IN CASE)
112
What are the characteristics of a Monopoly?
i) Very high barriers to entry
ii) One producer
iii) Unique Product
113
Note:
An oligopoly has a high market concentration ratio. A common rule of thumb
is that an oligopoly exists when the top five firms in the market account for more
than 60% of total market sales or production.
114
