Theory of The Firm (Beginning of topic)

Question 1

What type of assumption is it that a firm a firm aims to profit maximise

Answer 1

A neo classical assumption

Question 2

Firms are owned by shareholders and run by the B.O.D, what is this known as

Answer 2

The divorce of ownership and control

Question 3

How do shareholders make money

Answer 3

Capital appreciation
Through dividends

Question 4

Why do shareholders want profit maximisation

Answer 4

Increased dividends

Question 5

Why may the B.O.D not want profit maximisation

Answer 5

Job security (may mean less risk taking)
Salary maximisation (may mean growth over profit)

Question 6

What is an AGM

Answer 6

Annual General Meeting

Question 7

What occurs in an AGM

Answer 7

General meeting & the shareholders vote as to whether they want to re-elect the board of directors

Question 8

What is the definition of the long run

Answer 8

All factors of production are variable

Question 9

What is the definition of the short run

Answer 9

At least 1 factor of production (usually capital) is fixed

Question 10

What is the definition of production

Answer 10

Converting inputs into output

Question 11

What is productivity?

Answer 11

A measure of efficiency

Question 12

What is as a marginal cost

Answer 12

The extra cost incurred from producing one more unit of output

Question 13

What is marginal revenue

Answer 13

The extra revenue gained from selling one more unit of output

Question 14

Draw the diagram showing supernormal profit

Answer 14

Question 15

What is the profit maximising level of output

Answer 15

Where marginal costs (MC) are equal to marginal revenue (MR)

Question 16

What do marginal costs represent on the normal/supernormal profit diagram

Answer 16

Supply

Question 17

What does Average Revenue represent on the normal/supernormal profit diagram

Answer 17

Demand

Question 18

Why is the profit maximising point where marginal costs are equal to marginal revenue ?

Answer 18

Because at output levels before this point, you add more to revenue than cost, after this point you add more to cost than revenue

Question 19

What is normal profit

Answer 19

The minimum required to keep 1 factor of production in its present use

Question 20

What does supernormal profit provide the incentive for firms to do

Answer 20

Supernormal profit provides the incentives for factors of production to leave their current employment and re-deploy in the industry where supernormal profit can be made

Question 21

What is the main definition of a monopoly

Answer 21

A firm that has a significant proportion of total market share and is able to to influence price & quantity in the market
(They have market and pricing power)

Question 22

Draw the diagram showing normal profit (Monopolistic firms)

Answer 22

Question 23

What type of profit does a monopoly make in the long run

Answer 23

supernormal

Question 24

Why is a monopoly able to make supernormal profit in the long run

Answer 24

Due to barriers to entry

Question 25

What are barriers to entry

Answer 25

Factors which make entering a market difficult

Question 26

What is productive efficiency

Answer 26

The lowest point on the average cost curve

Question 27

Why are monopolies not productively efficient

Answer 27

They produce where mc=mr, not at the lowest point on the average cost curve

Question 28

How does the presence of supernormal profit lead to dynamic efficiency

Answer 28

Supernormal profit can lead to re-investment leading to lower long run average costs

Question 29

What is dynamic efficiency

Answer 29

Re-investment leading to lower long run average costs

Question 30

At what point is total output maximised

Answer 30

Where marginal revenue = 0 C

Question 31

When do firms shut down in the short run

Answer 31

If variable costs are not covered If variable costs are covered with a little over, it makes sense to stay in the market as fixed costs such as rent will remain even if you leave the market due to lease agreements etc. So by staying in the market and covering even a little bit of the fixed costs the business owner is benefiting If not even variable costs are covered as well as fixed costs then there’s it’s a loss when staying in the market If variable costs are covered but no fixed costs are covered, it doesn’t matter which you pick financially the outcome is the same

Question 32

Draw a diagram showing the different objectives of firms

Answer 32

Revenue max where MR=0 (Revenue is maximized when MR = 0, because that’s the point where producing one more unit costs nothing but also doesn’t increase revenue — so total revenue is at its peak.) Sales max where AR=AC (When AR = AC, the firm breaks even — earning zero economic profit so the sales-maximizing point under a zero-profit constraint occurs where AC = AR, because that’s the maximum output level a firm can produce without making a loss.) Pmax where MC=MR (A firm maximizes profit where marginal cost equals marginal revenue (MC = MR), because that's the point where producing more would no longer increase profit and producing less would reduce it.)

Question 33

Give 3 roles of profit

Answer 33

Investment in Research & Development (increasing efficiency and innovation) Reward for shareholders Attract new firms into an industry (signals demand) Enable higher wages for workers Tax revenue for gov (Corporation tax)

Question 34

Give 5 objectives of firms

Answer 34

Profit maximisation Sales maximisation (Netflix then they raised their prices after got many customers) Increased market share/market dominance (Aldi) Social/environmental concerns (Patagonia) Profit satisficing Revenue maximisation

Question 35

What is profit statisficing

Answer 35

In many firms, there is a separation of ownership and control. Those who own the company (shareholders) often do not get involved in the day to day running of the company. This is a problem because although the owners may want to maximise profits, the managers have much less incentive to maximise profits because they do not get the same rewards, (share dividends) Therefore managers may create a minimum level of profit to keep the shareholders happy, but then maximise other objectives, such as enjoying work, getting on with other workers. (e.g. not sacking them) This is the problem of separation between owners and managers.

Question 36

Give 4 barriers to entry

Answer 36

Brand loyalty Economies of scale Patents Significant capital requirements Intellectual components (e.g. competing with astrazeneca is hard because not easy to match their intellectual propperty) Heavy regulation (e.g. banking and insurance companies)

Question 37

Give 7 sources of monopoly power

Answer 37

Barriers to entry Advertising Product differentiation Lack of consumer information Formation of a cartel (e.g. OPEC) Brand loyalty Natural monopoly

Question 38

How does Lack of consumer information mean monopolies have more power

Answer 38

As consumers are unaware of all of their options and therefore may be deceived into buying a certain product, allowing monoply power to build up. This may be done through heavy advertising, making consumers believe that the best, or only type of a specific product is held with a certain firm

Question 39

How does advertising and product differentiation mean monopolies have more power

Answer 39

Advertising and product differentiation can help to enlarge perceived differences in products. This reduces the elasticity of demand for certain products and enables one firm to take control of a market, e.g. Apple.

Question 40

How does advertising and product differentiation reduce the elasticity of demand for certain products

Answer 40

Advertising and product differentiation can reduce the elasticity of demand by making consumers perceive a product as unique or essential, meaning they're less likely to switch to alternatives, even if prices rise

Question 41

What is market contestability

Answer 41

Market contestability refers to the ease with which new firms can enter and existing firms can exit a market. A highly contestable market has low barriers to entry and exit, meaning new competitors can readily challenge incumbent firms. This threat of entry, even if new firms don't actually enter, can discipline existing firms and drive down prices

Question 42

How does a natural monopoly act as a source of monopoly power (3)

Answer 42

High Fixed Costs and Low Marginal Costs Natural monopolies often have huge upfront costs (e.g., building infrastructure like water pipes, electricity grids, or railway systems) but very low costs to serve additional customers Barriers to Entry High infrastructure and setup costs prevent new firms from entering the market. Regulatory Protection – Government oversight can unintentionally shield the monopoly from competition.

Question 43

Whats the main difference between a monopoly and a monopolistic market

Answer 43

Monopolistic assumes no barriers to entry (Yet in reality there are a few, for example people may have brand loyalty to their local restaurant)

Question 44

What's the only efficiency that monopolistic firms show

Answer 44

Dynamic (they have some profit which they can use for investment, even though theoretically they do not make supernormal profit, but in reality things like branding and product differentiation means some firms do)

Question 45

What's the main difference between monopolistic markets and perfectly competitive markets

Answer 45

There is product differentiation, so demand is not perfectly elastic and firms are not price takers

Question 46

Give 3 examples of monopolistic markets

Answer 46

Restaurants Hairdressers Clothing (Basically anything where there is a differentiation in products/quality)

Question 47

Give 3 examples of limitations to the model of monopolistic competition

Answer 47

Some firms will be better at brand differentiation and therefore, in the real world, they will be able to make supernormal profit. New firms will not be seen as a close substitute. There is considerable overlap with oligopoly – except the model of monopolistic competition assumes no barriers to entry. In the real world, there are likely to be at least some barriers to entry If a firm has strong brand loyalty and product differentiation – this itself becomes a barrier to entry. A new firm can’t easily capture the brand loyalty. Many industries, we may describe as monopolistically competitive are very profitable, so the assumption of normal profits is too simplistic.

Question 48

When is PED elastic and when is it inelastic

Answer 48

Ignore sign, only look at numerical value PED>1 elastic PED<1 inelastic 0 - Perfectly inelastic infinity - Perfectly elastic 1 - Unit price elastic

Question 49

What is the equation for YED

Answer 49

YED= % change in D/% change in income

Question 50

What does the value of YED tell us for inferior and normal goods

Answer 50

Inverse relationship between demand and income, as income goes up, demand goes down and vice versa Unlike normal goods where as income goes up, demand goes up (LUXURY) and as income goes down, demand goes down (Necessity) NORMAL GOODS: YED>1 - Luxury (elastic) YED<1 - Necessity (inelastic) INFERIOR GOODS YED>1 - Elastic YED<1 - Inelastic If 0 then perfectly income inelastic

Question 51

What is XED

Answer 51

A measure of responsiveness of quantity demanded for a good/service given a price change of another good/service

Question 52

What is the formula for XED

Answer 52

XED + %change in demand for good A/% change in price of good B

Question 53

If XED is positive or negative, what does this tell us about the 2 goods

Answer 53

Positive - Substitutes Negative - Complements

Question 54

If XED is numerically less than or greater than 1, what does this tell us about the relationship between 2 goods

Answer 54

XED>1, close relationship (price elastic) XED<1, weak relationship (price inelastic) XED = 0, No relationship (perfectly inelastic)

Question 55

What affects PED

Answer 55

SPLAT Substitutes (many substitutes then will be price elastic) Proportion of income (the greater the price change is as a proportion of income, the more price elastic) Luxury (Luxuries more elastic, necessities inelastic) Addictive (more addictive the more price inelastic) Time period (in short run, inelastic because not many alternatives or time to look for them, in the long run elastic because new substitutes on the market and more time to look for them)