The Firm: Objectives, Costs and Revenues

Alvaro Ferreira6626
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Alvaro Ferreira6626
Created by Alvaro Ferreira6626 over 4 years ago
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Question Answer
Short Run Long Run The period of time in which at least one factor of production is fixed The period of time in which all factors of production are variable
Marginal Product The addition to total output by the extra unit of labour
Variable factor of production A factor of production that can be altered. E.g. Land/Labour
Why may a firm experience diminishing returns in the short run? In the short run we assume one factor of production is fixed. (Capital) If more workers are employed the marginal product results in an increase in output but at a less than proportional rate
Why may a firm experience increasing returns in the short run and returns to scale in the long run d79d76d9-5f95-4e25-97c1-c381dc15049e.gif (image/gif) Because in the long run the firm can temporarily overcome the problem of diminishing returns as it can vary its fixed costs. E.g. moving to a larger factory
Increasing returns to scale When an increase in factor inputs leads to a higher than proportionate increase in output
Diminishing returns Where an increase of a variable factor leads to a less than proportionate increase in total output as each unit is added.
Increasing marginal returns Where the addition of an extra variable factor adds more output than the previous variable factor.
What is the difference between Increasing marginal returns and Increasing returns to scale? Increasing marginal returns is where the addition of one variable factor adds to more output compared to the previous added factor whereas increasing returns to scale is the addition factor inputs which leads to a greater than proportionate increase in output
Why may a firm decide to choose to employ more capital rather than labour? Because Capital (Machinery) is a fixed cost, therefore it doesn't vary with changes in output as it can't be adjusted in the short term. However, labour is a variable cost because with short term changes in output more labour will be demanded.
Fixed costs Variable costs Total costs Costs of production that do not vary as output changes. E.g. Rent Costs of production that vary with output. E.g. Wages Fixed costs + Variable costs = TC
a0815a3d-dd30-4938-94fa-6e154526d724.gif (image/gif) Where MC=AC is the optimal output. This is the point where the firm has achieved the lowest cost combination between FC and VC. At this point the firm is productive efficient
Marginal Costs The cost of the extra unit of output
Why does the MC has the shape it does? dfce7ce6-db80-41a1-a158-ad70f34ae347.gif (image/gif) At first MC decreases as production increases due to specialisation of labour. However, after a certain point diminishing returns starts to settle as output rises so it will cost more for every extra unit of output
Why does the ATC shape the way it does? 9c7859e5-88b9-4882-ae18-7ea335a00d06.gif (image/gif) Because of the law of diminishing returns. Economies of scales occurs when an increase in output leads to a fall in the ATC. Diseconomies of scale occurs when an increase in output leads to a rise in the ATC
Minimum Efficient Scale 9b6ce22a-b15b-4427-9c5c-8d9ff441fc0f.gif (image/gif) This is the lowest point on the LRATC. This is the output of long-run productive efficiency
What is the possible structure of an industry with a MES of production that occurs at low levels of output? The possible structure could be a monopolistic structure because it is more likely to exploit economies of scale. A domestic firm with a small home market may need to export its goods to operate at the MES.
Economies of Scale Diseconomies of Scale When unit cost falls as output increases When a firm expands and leads to a rising unit cost
Internal Economies of scale Technical Economies of scale Firms that can afford to invest in expensive and specialist capital machinery. E.g. A supermarket buying automated stock control technology
Internal Economies of scale Specialisation of Labour Larger firms can split their jobs to different employees to boost productivity as they specialise in an specific job
Internal Economies of scale Financial Economies of scale Large firms have greater access to financial resources. For example, a firm listed in the stock market can access fresh capital or loans/overdrafts at a lower interest rate in comparison to a smaller firm.
External Economies of scale Infrastructure Local authorities improving the transport links for the town/city where the firm is located.
Diseconomies of scale Coordination Monitoring employees can be difficult if the firm expands too quickly
Diseconomies of scale Cooperation In large firms employees may feel like they are not part of the firm which therefore leads to a fall in productivity
Invention Innovation Coming up with a completely new idea or concept that can be patented The putting of an invention into commercial use
How can the adoption of new technologies affect the industry to make it more competitive? The adoption of new technologies can help a firm/industry become more competitive because undertaking R&D often leads to more innovative goods which therefore could mean the firm can lower their unit costs. E.g. New machinery increasing supply
Total Revenue Marginal Revenue Average Revenue Selling price x Units sold The addition to total revenue from the production of one extra unit of output Total revenue / Units sold
e78ab747-c6ef-47ed-a2cf-4c1eaf972579.png (image/png) b737ad47-0471-40bb-9912-238f521712c3.gif (image/gif)
Why does the MR curve slope more steeply than the AR curve? MR slopes more steeply than AR because both are constant with the difference that AR > MR with every extra unit of ouput produced.
Sales Revenue Maximisation MR=0 e42bf078-d1ff-4cd8-b3e0-2e93093370a6.png (image/png) At price PQ revenue is maximised. This enables the firm to keep its position in the market by keeping competition away and gain market share as a result of the firms main interest NOT being profits.
Average Cost Pricing cc0eb038-51b2-4c13-80cb-6bd3ae721198.jpg (image/jpg) Average cost pricing acts as a disincentive for other firms to enter the market. At this point the firm does not make SNP If government regulates the market the effect is the same The aim is to be productive efficient
Marginal Cost Pricing MC=AR 6f40a97c-049d-41b3-8807-90f5bf977bac.png (image/png) This is the point where the firm is allocative efficient. This is the optimum allocation of scarce resources that best accord with the consumers' pattern of demand. Marginal cost pricing is setting the price at the level of MC
Why is profit maximising where MC=MR? 4320b2bb-f149-41bc-bdd6-10b5c2b5b564.jpg (image/jpg) Because after MC and MR the marginal costs from producing an extra unit of output will be greater than the proportion of marginal revenue gained from it
Divorce of ownership and control Shareholders appoint directors to run the firm. Interest from stakeholders will always vary. Directors need to ensure that the firm is increasing in size but also make sure its profitable so that shareholders keep quiet (satisficing) and the firm removes the likelihood of a hostile bid.
Satisficing Hostile Bid The firm is producing satisfactory but not maximum profit A bid to buy shares in an attempt to gain control of the firm which is opposed by the firm's directors who fear job losses