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H2 Economics > Key Microeconomic Definitions > Flashcards

Key Microeconomic Definitions Flashcards

1
Q

Scarcity

A

Resources available for the production of g&s (limited) are insufficient to satisfy all human wants (unlimited)

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2
Q

Opportunity cost

A

Net benefit that could be derived from the NEXT BEST alternative foregone

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3
Q

Production Possibilities Curve (PPC)

A

Shows the COMBINATIONS of the maximum amount of 2 goods the economy can produce within a certain period, usually a year

  • fixed level of technology
  • all available resources are fully and efficiently employed
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4
Q

What are the assumptions of PPC?

A
  1. Specific period
  2. No change in state of technology (quality)
  3. Total available resources unchanged (quantity)
  4. All resources are fully utilised; latest technology used
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5
Q

What microeconomic concepts can the PPC show?

A
  • scarcity (attainable vs unattainable)
  • choice and allocative efficiency (a point on PPC)
  • opportunity cost (downward-sloping, concave to origin)
  • productive efficiency (on PPC)
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6
Q

What macroeconomic concepts can the PPC show?

A
  • full employment (on PPC) vs unemployment (inside PPC)
  • actual growth (inside to on PPC)
  • potential growth (outward shift of PPC)
  • investment-consumption choice; capital depreciation
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7
Q

Decision-making framework by economic agents

A
  1. Benefits vs costs
  2. Objectives
  3. Constraints
  4. Information
  5. Perspectives
  6. Intended, unintended consequences
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8
Q

Consumer decision-making

A

Maximise net total benefits (utility) (MC = MR)

  • what to consume
  • how much to consume
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9
Q

Producer decision-making

A

Maximise total profits (MC = MR)

  • what to produce (consumer preference; goods market; SR vs LR exit decision)
  • how much to produce (DD-SS intersection; goods market)
  • how to produce (method of production; factor market)
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10
Q

Government decision-making

A

Maximise net total social welfare (MSB = MSC)

  • whether to intervene
  • best policy to undertake
  • how many units to produce (merit goods, public goods, infrastructure; MSB = MSC)
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11
Q

Consumer constraints

A

Income; time (service)

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12
Q

Producer constraints

A

Financial resources; fixed factors in SR

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13
Q

Government constraints

A

Resources; financial resources; fiscal budget

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14
Q

Demand

A

Quantity of a good or service that consumers are WILLING and ABLE to consume at various prices, in a given time period

  • downward-sloping due to LDMU
  • shifted by TIGERP
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15
Q

Supply

A

Quantity of a good or service that producers are WILLING and ABLE to sell at various prices in a given time period

  • upward-sloping due to LDMR
  • shifted by PERMS
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16
Q

Income elasticity of demand (YED)

A

Measures responsiveness of demand to a change in income of a good, c.p

  • normal (necessity / luxury)
  • inferior
  • factors: nature of good, changing perception due to income level…
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17
Q

Cross-price elasticity of demand (XED)

A

Measures responsiveness of demand for one commodity to a change in price of another commodity, c.p

  • complementary
  • substitutes
  • independent
  • factor: closeness of subs
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18
Q

Price elasticity of demand (PED)

A

Measures responsiveness of Qd for a good to a change in its price, c.p

  • sign always (-)
  • price elastic vs inelastic
  • factors: no. and closeness of available subs (PDA), proportion of Y spent on good, time period
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19
Q

Price elasticity of supply (PES)

A

Measures responsiveness of Qs to a change in price, c.p

  • always (+)
  • price elastic vs inelastic
  • factors: time period, MC as o/p changes (spare capacity, mobile f.o.p), definition of good
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20
Q

Limitations of elasticity concepts

A
  1. assumes c.p
  2. based on past data
  3. based on small changes in price / income / price of other goods; inaccurate estimation
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21
Q

Consumer surplus

A

Difference between the maximum price that consumers are willing and able to pay for a good or service and the total amount they actually pay

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22
Q

Indirect tax

A

Compulsory levy imposed on the sale of goods and services, which the producer has the legal responsibility to pay to the government

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23
Q

Producer surplus

A

Difference between the minimum price that producers are willing and able to supply for a good for and the price they actually receive

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24
Q

Subsidy

A

A payment made by the government to producers to encourage the production of certain g&s, but not made in exchange for any goods and services

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25
Q

Allocative efficiency

A

Combination of goods and services produced maximises the total economic welfare of society (MSB = MSC)

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26
Q

Market failure

A

A free market fails to allocate resources efficiently from society’s point of view as it produces and consumes the wrong quantities of a particular good/service (not desired by society)

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27
Q

Assumptions of a free market

A
  1. Private good
  2. Absence of externalities
  3. Perfectly competitive market with perfect information, perfect factor mobility and absence of market dominance by any firm (PC firm)
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28
Q

Free market economy

A
  • no government intervention
  • individuals and firms free to pursue self-interest
  • consumers seek to maximise their net TPB
  • firms seek to maximize their total profits.
  • individuals decide what and how much to consume + how much of resources and whom they wish to supply to
  • firms decide what, how much and how to produce
  • profit-motivated firms will produce goods to meet the preferences of consumers, only if it is profitable
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29
Q

Price mechanism

A

Interaction of decisions undertaken by individuals and firms to determine the allocation of scarce resources between competing uses, as limited resources are met with unlimited wants, giving rise to scarcity.

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30
Q

Signalling role of price

A
  • what and how much to produce of a g&s

- how to produce (optimal mix of f.o.p, relative factor prices; assume same productivity)

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31
Q

Rationing role of price

A
  • for whom to produce (distribution of g&s): shortage / surplus -> only those willing & able to pay get the good
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32
Q

Consumer sovereignty in the free market

A

Consumers are able to vote for what they want firms to produce through their purchases, and vote against by not buying it (dollar votes) -> determine what and how much to produce

In turn, firms will only produce those goods at prices they are willing to accept.

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33
Q

Why is DD = MPB?

A
  • rational consumers aim to maximise net TPB
  • will buy an additional unit as long as MPB (utility) > MPC (price)
  • maximum price a consumer is willing to pay for one more unit of a good (DD) = marginal utility from consuming that additional unit
  • market DD = MPB
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34
Q

Why is SS = MPC?

A
  • rational producers aim to maximise total profits
  • willing to sell an additional unit of the good as long as MPB (additional revenue) > MPC (mCOP)
  • minimum price a producer is willing to accept to produce 1 more unit of a good (SS) = marginal cost incurred from producing that additional unit
  • market SS = MPC
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35
Q

Positive externalities of healthcare / vaccination (CONSUMPTION)

A

Workers are healthier and more productive -> lower mCOP for firms -> higher profits

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36
Q

Positive externalities of education (CONSUMPTION)

A

Country becomes more attractive to foreign investments -> create jobs for others in country; get to earn income

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37
Q

Positive externalities of R&D (PRODUCTION)

A

Other companies benefit from knowledge of technology, more efficient method of production, etc.

  • adapt innovation in own companies
  • earn higher profits due to fall in mCOP
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38
Q

Positive externalities of training workers (PRODUCTION)

A

Worker becomes more productive; if he finds employment elsewhere, new employer benefits from higher productivity and savings in training COSTS

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39
Q

Negative externalities of car usage (CONSUMPTION)

A

Longer travelling time, health problems -> lower productivity for firms

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40
Q

Negative externalities of air & sea pollution (PRODUCTION)

A

Oil spills damage marine ecosystems and reduce fishermen’s EARNINGS

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41
Q

Merit goods (e.g. health screenings, museum visits, education)

A
  • deemed socially desirable by government
  • underconsumed when left to price mechanism
  • due to consumers’ failure to recognise true benefits to themselves + disregard external benefits
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42
Q

Demerit goods (e.g. cigarettes, alcohol, sugary beverages, plastic bags)

A
  • deemed socially undesirable by government
  • overconsumed when left to price mechanism
  • due to consumers’ failure to recognise true costs to themselves + disregard external costs
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43
Q

Sources of imperfect information

A
  • consumer ignorance
  • adverse selection
  • moral hazard
  • supplier-induced demand
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44
Q

Adverse selection (e.g. used car market, insurance market)

A
  • asymmetric information between consumers and producers before transaction
  • unfavourable selection of products or buyers participating in the market
  • a segment of other buyers/sellers is priced out of market
  • potential net benefit to society from having some sales of that g&s is lost / having some low-cost customers insured is lost
  • but socially optimal outcome is to have some sales of that g&s, where willing buyers and sellers are matched in the market
  • if more high-risk customers make claims of very high value and claims > total revenue from premiums, unprofitable and insurance companies will close -> no market
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45
Q

Lemon

A

Poor quality product

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46
Q

Cherry or plum

A

High quality product

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47
Q

Moral hazard (e.g. insurance) / principal-agent problem

A

Economic agents take greater risks / act less carefully than they normally would because the resulting costs will not be borne by them (after transaction)

  • agent takes unobserved action as it cannot be perfectly monitored by the principal
  • no mutually advantageous trade
  • potential net benefit to society from having those g&s traded is lost
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48
Q

Supplier-induced demand (e.g. car repairs, doctor-patient)

A

Producer has more information than consumer -> lead consumers to buy more g&s than what is optimal for them (during transaction)

  • producers are profit-motivated
  • consumers’ perceived MPB > true MPB
  • overconsumption of Q-Q* units
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49
Q

Occupational immobility

A

Inability and/or unwillingness of f.o.p to move between occupations / industries / sectors

  • lack of transferrable skills
  • lack of natural talent
  • barriers: TUs and professional associations
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50
Q

Geographical immobility

A

Inability and/or unwillingness of f.o.p to move between geographical areas

  • family and social ties
  • high costs of moving
  • different costs of living
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51
Q

How does factor immobility lead to allocative inefficiency?

A
  • unemployment and wastage of resources
  • not fully utilising resources available
  • no productive efficiency
  • economy cannot obtain sufficient f.o.p to produce at the socially optimal level of output
  • too little resources channeled into a particular expanding sector
  • cannot get desired amount of labour to increase Qs in growing sector to meet rise in demand; cannot produce at socially optimal level of output
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52
Q

Policy effectiveness

A
  • achieve intended outcome
  • target root causes
  • time taken
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53
Q

Policy appropriateness

A
  • unintended consequences or trade-offs
  • long term sustainability
  • cost efficiency
  • public acceptability; political popularity
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54
Q

Rationale of tax

A
  • Discourage consumption / production of a particular good (e.g. demerit good)
  • Raise tax revenue to finance government spending
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55
Q

Production tax (adjustable)

A

A tax on output to reduce consumption / production levels to socially optimal level

  • per unit tax = MEC at Q*
  • firms internalise external costs
  • SS falls by amount of MEC (mCOP rise) at Q*
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56
Q

Pollution tax

A

A compulsory levy imposed on producers, where firms have to pay the government a fixed fee per unit of pollution generated

  • MPB of lowering pollution: avoid paying tax
  • MPC of lowering pollution: install equipment to reduce emissions, R&D, etc.
  • firms choose to lower pollution if MPB > MPC
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57
Q

Production subsidy (can be adjusted according to MEC / type of good and level of necessity to poor)

A

A payment made by the government to producers to encourage production of certain goods/services, but not made in exchange for any goods/services

  • per unit subsidy = MEB at Q*
  • firms internalise MEB
  • SS increases by amount of MEC at Q* (fall in mCOP)
  • surplus at original price level
  • downward pressure
  • lower price incentivises consumers to increase Qd to Q*
  • if initially a.e. and targets equity, trade-off with a.e / distort other markets by raising funds for subsidies through taxes
58
Q

Rationale of subsidies

A
  • Encourage overall consumption / production of a particular good (e.g. merit good)
  • Make a good more affordable for the poor (when producers pass on cost savings they receive from subsidies to consumers)
59
Q

Tradeable permits

A

Permits to pollute issued to firms by a government or an international body, which can be traded (bought & sold) in a market

  • govt decides on optimal level of pollution that is allowable
  • auction the corresponding no. of permits to pollute directly to firms or distribute permits to firms
  • firms are free to buy and sell permits with each other; price of permits determined in market by demand and supply forces
  • firms with low cleanup costs would rather pollute less than quota assigned to them; incentivised to find cleaner methods of production to reduce pollution, then sell surplus
  • firms with high cleanup costs would wish to pollute above quota of permits initially allocated to them → buy permits from firms with low cleanup costs
  • overall pollution level reduced to total allowable pollution set by government
60
Q

Grant

A

A lump sum payment for a specific purpose

  • Increase consumer’s / producer’s ability to spend on the good/service
  • Increase their demand & consumption / production of the good or service to the socially optimal quantity
61
Q

Direct provision

A

Government takes over production and supplies the good directly to consumers

  • ensures certainty in producing the good that society wants at socially optimal qty and price
  • can be financed through taxes
  • OR provide funding and outsource production and maintenance of goods to private producers by awarding them contracts; more productive efficient
  • extend MPB to MPB = 0, then dot up to MSB and MSC
  • can create a smaller welfare loss than original
62
Q

Joint provision

A

Private and public sectors produce the good together

  • private sector: competition for government enterprise; dynamic efficiency
  • public sector: address underproduction by private sector
63
Q

Regulation

A
  • uses the law to compel certain actions to be taken by consumers/firms
  • if violate, face punishment in form of fines or imprisonment
  • compels consumers / firms to change their behaviour
64
Q

What are some examples of regulations?

A
  • standards on emissions, lead and benzene content in petrol
  • command use of particular methods to reduce negative externalities (e.g. install catalytic converters)
  • limit sale/use of goods at certain times or places (e.g. alcohol sale times, smoking zones)
65
Q

Total ban

A

Zero quantity of the good is consumed or produced

  • extend MSC and MPC curves to 0
  • output drops from Q to 0
  • society doesn’t incur original welfare loss of overproducing by Q-Q* units, but also loses net TSB from consuming/producing 0-Q* units
66
Q

Quota

A

A form of quantity control

  • government regulates quantity of good that can be offered for sale
  • govt fixes maximum quantity of goods that can be sold to Q2 (less than Q)
  • equilibrium price increases to P2
67
Q

Lemon Law

A
  • sellers have to replace or repair defective goods and allow buyers right to a discount / refund if not possible
  • sellers of defective goods can be punished
  • buyers assured of quality; more willing to pay higher prices for cherries
68
Q

Other laws to address adverse selection

A
  • prevent fraudulent misrepresentations in sale of defective products
  • minimum safety standards for consumer products
69
Q

Public education (e.g. national campaigns, label cigarette packs)

A

Provide information to educate consumers on true MPB of consuming the good

  • improve consumers’ individual decision-making
  • more willing; demand increases to true MPB
70
Q

Factors the government will consider in market failure policies

A
  1. extent of market failure** (intervene in first place?)
  2. effectiveness in achieving outcome** (choice of policy)
  3. root cause**
  4. unintended consequences or trade-offs in other markets**
  5. long-run sustainability? (choice of policy)
  6. cost efficiency? (choice of policy)
  7. constraints like budget?
  8. even if they intervene, will it change the current situation much?
71
Q

Equity

A

Distribution of goods and services that is considered to be fair or just

72
Q

How does income inequality lead to inequity?

A
  • unequal income distribution; unequal ability to pay
  • free market allocates resources to produce g&s for consumers willing, able to pay
  • higher income can cast higher dollar votes
  • profit-motivated producers divert more scarce resources to produce luxury goods for the rich
  • overallocation of scarce resources to rich and less to poor; unfair
73
Q

What are the causes of income inequality?

A
  1. unequal factor endowment + wealth accumulation over generations
  2. difference in price of f.o.p one offers (e.g. skilled vs unskilled labour)
74
Q

Wealth

A

Stock concept

- physical assets that one has at a particular point in time

75
Q

Labour demand

A

No. of workers firms are willing and able to hire at different wage rates, c.p

  • derived demand
  • downward-sloping
  • movement along due to change in w/r
76
Q

What happens if w/r rises?

A
  • rise in production costs; lower profits c.p.
  • firms lower output or substitute with other cheaper f.o.p
  • lower Qd for labour
77
Q

Labour supply

A

Quantity of labour supplied by households at different w/r, c.p.

  • upward sloping
  • leisure incurs opportunity cost
  • higher w/r, higher opportunity cost of labour
78
Q

What causes a SHIFT in labour demand by firms?

A
  1. change in price of output
  2. higher productivity of labour (higher output per unit input); higher revenue contributed with same quantity of factor input
  3. change in price of related f.o.p (if price changes in another f.o.p market)
79
Q

What causes a SHIFT in supply of labour?

A
  1. change in no. of qualified people available (e.g. after retraining)
  2. actions of trade unions: control supply of union workers (e.g. limit working hours, strikes)
80
Q

What causes wage differentials between occupations?

A

Difference in LEVELS of DD and SS for occupations

81
Q

What causes a lower LEVEL of supply?

A
  • level of natural ability
  • length, cost of training and education (ability and desire to go through?)
  • extent of government regulation on SS of foreign labour (e.g. influx)
  • trade unions
  • non-monetary attributes like risks
82
Q

What causes a higher LEVEL of demand?

A

Certain occupations generate more revenue for any given level of employment
- contribute more additional revenue to firm

83
Q

What causes persistent wage differentials?

A

Geographical / occupational immobility of labour

84
Q

Maximum price / price ceiling

  • highly cost effective
  • immediate
A

Maximum permissible price that producers may legally charge for the good

  • set below market equilibrium price
  • causes a shortage at the max price; needs an alternative allocation system (e.g. rationing, seller’s preference, FCFS)
  • causes welfare loss due to underproduction and obscuring of price signals that guide resource allocation
  • loss in PS
  • effect on CS uncertain; some consumers now priced out
  • [LR] over time, as f.o.p become variable, producers lower Qs with lower price received, worsening the price shortage
  • prolonged shortage can cause black market
85
Q

Minimum price / price floor

A

Minimum permissible price that producers may legally charge for a good

  • above market equilibrium price
  • surplus at Pmin; bought up by government (incurs expenditure)
  • loss in CS (consume less, pay more)
  • gain in PS
  • net welfare loss is V-neck rectangle
  • prices can recover to equilibrium price over time
  • if PED elastic, rise in price will cause more than proportionate fall in Qd and fall in TR unless government buys up surplus
  • may not be dynamic or productive efficient if complacent
  • waste if surplus stock is perishable
86
Q

Minimum wage legislation

A

Workers get a wage above market equilibrium wage; legally imposed by government

  • causes uN as Qd falls (depends on PED and extent by which min wage is higher than eqm w/r)
  • can cause allocative inefficiency as Qd < efficient quantity of labour (Qe)
  • can cause illegal unemployment (work below w/r); defraud govt of income tax
87
Q

Direct taxation

A

Taxies levied by government directly on income and wealth of individuals and firms

88
Q

Corporate tax

A

Firms are taxed a percentage of their profit

89
Q

Personal income tax

A

Individuals are taxed a percentage of their annual income

90
Q

Progressive income tax

A

Taxes a larger % of income from high income earners than low income earners

  • reduce post-tax income of rich
  • redistribute to poor in form of subsidies, transfer payments
  • stifles work incentives (lower marginal return to work effort); brain drain; underemployment & productive inefficiency
  • stifles investment incentives (higher Y are source of loanable funds for I)
91
Q

Transfer payments

A

Any expenditure by the government for which it receives no goods and services in return

  • direct cash payments
  • increase disposable income
  • criteria-based (admin costs)
  • not under compulsion to spent
  • doesn’t distort price signals
  • households enjoy FULL extent of benefit, unlike subsidies
  • ad hoc
  • crutch mentality
92
Q

Government vouchers & in-kind transfers

A

Households can redeem vouchers in exchange for specific g&s

  • higher ability to consume goods
  • more targeted (provided perfect info) vs subsidies or TPs
  • ad hoc
  • may expire
  • can cause allocative inefficiency due to overconsumption (TSC > TSB)
  • crutch mentality
93
Q

How does skills upgrading address inequity?

A
  • workers can enter industries with higher DD and earn higher wages
  • become more productive; enjoy higher wages
94
Q

What factors does the government consider when deciding its method of intervention towards a problem?

A

Government chooses measure that yields most benefits at least costs, subject to constraints

  • effectiveness (achieve intended outcome, assumptions, root causes, time)
  • appropriateness (trade-offs, fiscal sustainability, cost efficiency - least cost?)
  • nature of good (e.g. essential)
  • nature and extent of problem
  • nature of country
95
Q

What factors does the government consider when deciding between alternative projects or policies?

A

Choose the project with highest net TSB, subject to budget constraints

  1. weigh net TSB between the two (consider TSB and TSC of each project)
    - private
    - external
  2. budget constraints; competing uses for funds; opportunity cost
96
Q

What factors does the government consider when deciding whether to intervene at all?

A
  1. Benefits vs costs of intervention
    - compare outcome in free market vs government intervention
    - benefit: increase social welfare (consider extent of problem)
    - costs: monetary costs to government (e.g. gather info, admin, monitoring, i/r for loans, buy up surplus)
97
Q

What are the limitations of government decision-making?

A
  • imperfect info: calculate costs and benefits, welfare loss, MEC, MEB, MSB, MSC; hard to estimate benefits of intervention
  • government will: corruption? self-interest?
98
Q

Government failure

A
  • government fails to improve market outcomes; made worse

- inappropriate method of intervention

99
Q

Factors causing government failure

A
  • trade-off between equity and efficiency (can be deliberate, depending on priority of goal)
  • lack of profit motivation: not productive or dynamic efficient due to lack of competition
  • policy myopia: short-term solutions or quick fixes; doesn’t address structural problems or root causes
  • imperfect info; overcorrection
  • unintended consequences that worsen social welfare; people’s behaviour changes over time
  • time lag in recognition / implementation / impact
100
Q

What is market power?

A

The FIRM’S ability to influence the market price of the good it sells w/o losing all its sales

101
Q

What are the indicators of market power?

A
  1. Degree of product differentiation -> PED, XED

2. Level of barriers to entry

102
Q

What does the degree of product differentiation determine?

A

Closeness of the firm’s products to available substitutes in the market

103
Q

What does the degree of product differentiation depend on?

A

Real and/or imaginary differences between products in the market

104
Q

What does the level of BTE determine?

A

The number of firms in the market and availability of substitutes produced by competitors
- how willing potential competitors are to enter the market

105
Q

What does the level of BTE depend on?

A
  1. Natural barriers

2. Artificial barriers

106
Q

What are natural BTE?

A
  • financial: huge initial capital expenditure
  • inability to reap internal EOS, unlike incumbent firms (output not large enough yet), e.g. natural monopoly
  • transport costs and localised monopolies in geographical areas
107
Q

What are artificial BTE?

A
  • government / legal rights (e.g. patents, copyright, licenses earned, trade barriers against foreign firms)
  • strategic entry deterrence to discourage entry (e.g. limit pricing)
  • aggressive tactics (e.g. advertising)
108
Q

Market share

A

% of A FIRM’S output value out of the total output value of the industry.

109
Q

Market concentration ratio

A

% of total market output value supplied by the LARGEST FEW FIRMS in the industry.
- combined market share of these firms.

110
Q

What are EXPLICIT costs of production?

A

Actual monetary payment made by a firm to buy f.o.p not originally owned by them

111
Q

What are IMPLICIT costs of production?

A

Opportunity costs of using f.o.p already owned by firms; net benefit of next best alternative (business) foregone

112
Q

Short run period

A

At least 1 fixed f.o.p

- TC = TVC + TFC

113
Q

Long run period

A

All f.o.p are variable; firms can expand

- TC = TVC

114
Q

Very long period

A

Includes technology

  • produce same amount of goods with lower input
  • produce more goods with same amount of inputs
115
Q

Fixed costs (FC); only in SR

A

Costs that do not vary with output level of firm

- costs of fixed f.o.p

116
Q

Variable costs (VC); in SR and LR

A

Costs that vary positively and proportionately with output level

  • VC = 0 with no production
  • costs of variable f.o.p
117
Q

Marginal costs (MC)

A

Addition to TC arising from an additional unit of output

  • MC = VC
  • change in TVC over change in TC
118
Q

Average total cost (ATC) / average cost (AC) / unit cost

A

Total cost per unit of output

  • ATC = AVC + AFC
  • TC over o/p
119
Q

Average variable cost (AVC)

A

Variable costs per unit of output

- TVC over o/p

120
Q

Average fixed cost (AFC)

A

Fixed costs per unit of output

- TFC over o/p

121
Q

Take note for drawing firm diagrams

A
  • all curves apply to SR period
  • MC cuts AVC and ATC from below
  • MC intersects both AVC and ATC at their minimum
  • as o/p increases, gap between AVC and ATC gets smaller
  • as o/p increases, TFC decreases as it is spread over a larger output; AFC curves downwards
122
Q

LRAC curve (long run period; all f.o.p are variable)

A

Definition: lowest possible unit cost a firm can produce at any given output level in LR, when all inputs are variable

  • U shaped due to LDMR
  • all points are productive efficient
  • SHIFTED by external EOS
  • movement along by internal EOS
123
Q

Minimum efficient scale (MES)

A

Beyond this output, firm ceases to enjoy internal EOS

  • skewed to left for small firms
  • skewed to right for large firms; can exploit EOS to a very large o/p
  • range (horizontal line) for firms of varying sizes (e.g. in an oligopoly); range of possible scales of production and won’t be at cost disadvantage to competitors
124
Q

What is the market diagram for a firm with NO MP?

A
  • price taker
  • DD = P = AR = MR
  • demand is perfectly price elastic
  • firm sells every additional unit at same price
  • MR = constant price as o/p increases
125
Q

What is the market diagram for a firm with MP?

A
  • price setter
  • DD = P = AR
  • MR < DD; MR is twice as steep
  • DD is downward-sloping: firm sells an additional unit only by lowering price for both the extra unit and all the previous units
126
Q

How does a PC firm determine its o/p and price?

A
  • in the market, price (Pc) is where DD = SS
  • firm will produce at where MR = MC and charge the industry price of Pc
  • draw market and firm diagrams side by side; extend price line from market to firm diagram
127
Q

How does an ImPC firm determine its o/p and price?

A
  • produce where MR = MC

- can fully exploit MP by charging the highest price consumers are able and willing to pay (DD curve)

128
Q

What are some assumptions made when an ImPC firm determine its o/p and price the “traditional” way?

A
  1. Firms have knowledge of DD, MR curve
  2. No rival consciousness to influence pricing decision (e.g. price leadership, competitive price cuts)
  3. Firms not regulated by government intervention (e.g. must charge P = MC or P = AC)
129
Q

Supernormal profits

A

P > ATC; TR > TC

  • over and above normal profits
  • firm is earning more than it could in the next best alternative business
  • attracts entrants in LR
  • TR - TC = (+) area
130
Q

Normal profits

A

P = ATC; TR = TC

  • earn similar amount as next best alternative
  • won’t attract or deter entrants
  • TR - TC = 0
131
Q

Subnormal profits

A

P < ATC; TR < TC

  • firm earns losses; less than it could in the next best alternative
  • leave industry in the long run
  • TR - TC = (-)
132
Q

Short run shut down decision

A
  • at least one fixed f.o.p
  • if P < ATC and P > AVC, continue production
  • if P < ATC and P < AVC, shut down to limit losses to TFC
  • if P = AVC, indifferent but likely continue production
133
Q

Long run exit decision

A
  • all f.o.p are variable

- exit if P < ATC (earning subnormal profits)

134
Q

Firm

A

Organisation that brings together f.o.p to produce g&s

135
Q

Industry

A

A group of firms producing similar g&s

136
Q

Why may firms not produce at the profit-maximising level?

A
  • willing but unable due to lack of perfect info on revenue and cost conditions; dynamic environment; hard to estimate PED
  • avoid changing prices in oligopoly
  • alternative objectives
  • government regulation (e.g. pricing)
137
Q

Alternative objectives of firms

A
  • market dominance
  • entry deterrence
  • revenue maximisation
  • profit satisficing
  • social objectives
138
Q

Technical/plant internal EOS

A
  • Linked processes
  • Indivisibilities of capital
  • Principle of increased dimensions
  • Specialisation
139
Q

Firm internal EOS

A
  • Financial (access to loans, i/r)
  • Administrative/managerial (more efficient)
  • Risk-bearing (bear risks of R&D over larger range of output)
  • Marketing (economies of scope, bulk discounts)
140
Q

External EOS

A
  • Concentration (sharing a pool of similar resources)
  • Information (share info and knowledge; spread R&D costs)
  • Disintegration (outsource production to firms that can produce components more cheaply; subsidiary firms enjoy their own internal EOS)
141
Q

Internal disEOS

A
  • problems in communication and coordination; conflicting objectives
  • problems in labour motivation and productivity due to breakdown in labour relations, isolation in specific tasks
142
Q

External disEOS

A
  • shortage of industry-specific resources when firms compete and increase price of inputs
  • strain on physical infrastructure; overutilization of common infrastructure

H2 Economics (2 decks)

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