Traditional Theory of the Firm

Question 1

What is the core assumption of the Traditional Theory of the Firm?

Answer 1

Profit Maximisation

Central to neoclassical microeconomics.

Question 2

What is the primary objective of firms according to the Traditional Theory of the Firm?

Answer 2

Maximising economic profit (π)

This reflects the aim of firms in a competitive market.

Question 3

What rationale supports the profit maximisation objective in the Traditional Theory of the Firm?

Answer 3

Scarce resources and rational actors ensure optimal allocation and efficiency

This rationale is foundational to neoclassical economics.

Question 4

What is the condition for profit maximization in the Traditional Theory of the Firm?

Answer 4

Profit is maximised at the vertical distance between TR and TC being greatest.

TR stands for Total Revenue and TC stands for Total Cost.

Question 5

What characterizes the short-run in the Traditional Theory of the Firm?

Answer 5

Some costs are fixed; firms may operate at suboptimal scales.

In the short run, firms cannot adjust all input levels.

Question 6

What characterizes the long-run in the Traditional Theory of the Firm?

Answer 6

All inputs are variable; firms can adjust scale to reach minimum efficient scale.

The minimum efficient scale is the lowest point where long-run average costs are minimized.

Question 7

Fill in the blank: Profit is maximised when the vertical distance between _______ and _______ is greatest.

Answer 7

TR and TC

Question 8

True or False: In the long-run, firms cannot adjust their input levels.

Answer 8

False

In the long-run, all inputs are variable.

Question 9

What is the profit-maximising output in the MR = MC approach?

Answer 9

The intersection point of MR and MC

MR stands for Marginal Revenue, and MC stands for Marginal Cost.

Question 10

In perfect competition, what is the relationship between MR and P?

Answer 10

MR = P

This means profit maximisation occurs where price equals marginal cost.

Question 11

Under what market condition does MR slope downward?

Answer 11

Under monopoly/imperfect competition

This occurs due to the market power held by the firm.

Question 12

Fill in the blank: The profit maximisation occurs where _______.

Answer 12

P = MC

Question 13

True or False: In perfect competition, the profit-maximising condition is achieved when MR is greater than MC.

Answer 13

False

In perfect competition, profit maximisation occurs when MR equals MC.

Question 14

What condition allows firms to continue operating in the short run?

Answer 14

Firms may continue operating if they cover variable costs (i.e., P ≥ AVC).

P represents price, and AVC represents average variable cost.

Question 15

What is the shutdown condition for firms in the short run?

Answer 15

P < AVC.

This indicates that the price is below average variable costs, making it unfeasible for firms to continue operations.

Question 16

What drives firms to enter or exit the market in the long run?

Answer 16

Profit signals.

Firms are motivated by the potential for profit or loss in the market.

Question 17

What type of profit is associated with equilibrium in the long run?

Answer 17

Normal profit (i.e., zero economic profit).

Normal profit indicates that firms are covering all costs, including opportunity costs.

Question 18

What ensures allocative and productive efficiency under perfect competition?

Answer 18

Equilibrium occurs where firms earn normal profit.

Allocative efficiency means resources are distributed according to consumer preferences, while productive efficiency means goods are produced at the lowest possible cost.

Question 19

What is the primary assumption of profit maximisation in traditional theory?

Answer 19

Profit maximisation assumes perfect foresight and complete information

This is often not the case in real-world situations.

Question 20

What does risk and uncertainty imply for real-world firms compared to traditional theory?

Answer 20

Real-world firms operate under conditions of uncertainty where demand, costs, and competitor behaviour are unpredictable

This contrasts with the traditional theory’s assumptions.

Question 21

What is asymmetric information in the context of traditional economic theory?

Answer 21

Asymmetric information refers to firms facing incomplete or distorted information that hinders optimal decision-making

Traditional theory assumes firms have accurate, symmetrical knowledge.

Question 22

Define the principal-agent problem.

Answer 22

The principal-agent problem arises when the separation of ownership and control allows managers to pursue objectives diverging from shareholder profit

Traditional theory treats the firm as a single rational entity.

Question 23

What concept does Herbert Simon introduce that challenges traditional profit maximisation?

Answer 23

Satisficing behaviour

This concept suggests firms aim for acceptable outcomes rather than optimal ones due to bounded rationality.

Question 24

List alternative behavioural objectives identified by Marris, Baumol, and Williamson.

Answer 24

• Growth
• Sales
• Managerial utility

These objectives reflect diverse motivations beyond pure profit.

Question 25

What does transaction cost economics reveal about traditional economic theory?

Answer 25

Transaction cost economics reveals that contracts, negotiation, enforcement, and coordination costs significantly shape firm behaviour and organisational boundaries ## Footnote Traditional theory assumes frictionless markets and instantaneous adjustments.

Question 26

True or False: Traditional economic theory assumes firms operate with complete information.

Answer 26

True ## Footnote This assumption does not hold in practice due to real-world complexities.

Question 27

Fill in the blank: Bounded rationality leads firms to aim for _______ outcomes rather than optimal ones.

Answer 27

acceptable ## Footnote This challenges the traditional view of full rationality.

Question 28

What is the profit maximisation model considered to be?

Answer 28

A stylised abstraction ## Footnote The model is analytically elegant and foundational for comparative statics.

Question 29

Why is the profit maximisation model seen as limited?

Answer 29

It increasingly fails to explain firm behaviour in real-world markets ## Footnote Real-world markets are often imperfectly competitive and institutionally complex.

Question 30

What do alternative models provide in the context of firm behaviour?

Answer 30

Better explanations for firm behaviour in imperfectly competitive and institutionally complex markets ## Footnote These models address the limitations of the profit maximisation model.

Question 31

Fill in the blank: The profit maximisation model is increasingly seen as a _______.

Answer 31

stylised abstraction

Question 32

True or False: The profit maximisation model is the only model used to explain firm behaviour.

Answer 32

False ## Footnote Alternative models exist that better explain firm behaviour.