Thursday, April 3, 2014

MRF0013: Basic Economics: Chap 9, 10, 11 & 12.

Chapter 9: Cost of Productions.

Opportunity cost: Cost measured in terms of the next best alternative forgone.

Explicit costs:  The payments to outside suppliers of inputs.

Implicit costs:  Costs which do not involve a direct payment of money to a third party, but which nevertheless involve a sacrifice of some alternative.

Historic costs:  The original amount the firm paid for factors it now owns.

Sunk costs:  Cost that cannot be recouped (eg: by transferring assets to other uses)

Replacement costs:  What the firm would have to pay to replace factors it currently owns.

Total physical product:  The total output of a product per period of time that is obtained from a given amount of inputs.

Production function:  The mathematical relationship between the output of a good and the inputs used to produce it.   It shows how output will be affected by changes in the quantity of one or more of the inputs.

Fixed costs:  Total costs that do not vary with the amount of output produced.

Variable costs:  Total costs that do vary with the amount of output produced.

Total Cost (TC):  The sum of total fixed costs (TFC) and total variable costs (TVC)

Average total cost (AC):  Total cost (fixed plus variable) per unit of output

Average fixed cost (AFC):  Total fixed cost per unit of output.

Average variable cost (AVC):  Total variable cost per unit of output

Marginal cost (MC):  The cost of producing one or more unit of output.
MC = <>TC / <>Q

Economies of scale:  When increasing the scale of production leads to a lower cost per unit of output.

Specialization and division of labour:  Where production is broken down with a number of simpler, more specialized tasks, this allowing workers to acquire a high degree of efficiency.

Indivisibilities:  The impossibility of dividing a factor of production into smaller units.

Plant economies of scale:  Economies of scale that arise because of the large size of the factory.

Retionalisation:  The reorganising of production (often after a merger) so as to cut waste and duplication and generally to reduce costs.

Overheads:  Costs arising from the general running of an organisation, and only indirectly related to the level of output.

Economies of scope:  When increasing the range of products produced by a firm reduces the cost of producing each one.

Diseconomies  of scale:  Where costs per unit of output increase as the scale of production increases.

External economies of scale:  Where a firm's costs per unit of output decrease as the size of the whole industry grows.

Industry's infrastructure:  The network of supply agents, communications, skills, training facilities, distribution channels, specialised financial services, etc that support a particular industry.

External diseconomies of scale:  Where a firm's costs per unit of output increase as the size of the whole industry increases.

Technical or productive efficiency:  The lease-cost combination of factors for a given output.

Long-run average cost (LRAC) curve:  A curve that shows how average cost varies with output on the assumption that all factors are available.  (It is assumes that the least-cost method of production will be chosen for each output).

Long run equilibrium: LARC = AC = MC = MR = AR

Envelope curve:  A long-run average cost curve drawn as a tangency points of a series of short-run average cost curves.

Chapter 10: Revenue and profit.

Total Revenue: A firm's total earnings from a specified level of sales within a specified period
TR = P X Q

Average revenue:  Total revenue per unit of output.  When all output is sold at the same price, average revenue will be the same as price.
AR = TR/Q = P

Marginal revenue:  The extra revenue gained by selling one or more unit per time period
MR = <>TR / <>Q

Price taker: A firm that is too small to be able to influence the market price.

Price maker (price chooser):  A firm that has the ability to influence the price charged for its good or service.

Profit-maximizing rule:  Profit is maximized where marginal revenue equals marginal cost.

Normal profit:  The opportunity cost of being in business.  It consists of the interest that could be earned on a risk-less asset, plus a return for risk-taking in this particular industry.  It is counted as a cost of production.

Supernormal profit (also known as pure profit, economic profit, abnormal profit or simply profit):  The excess of total profit above normal profit.

Short-run shut-down point:  This is where the AR curve is tangential to the AVC curve.  The firm can only just cover its variable costs.  Any fall in revenue below this level will cause a profit-maximizing firm to shut down immediately.

Long-run shut-down point:  This is where the AR curve is tangential to the LRAC curve.  The firm can just make normal profits.  Any fall in revenue below this level will cause a profit-maximizing firm to shut down once all costs have become variable.

Chapter 11: Profit maximization under perfect competition and monopoly.

Perfect competition:  A market structure in which there are many firms, where the is freedom of entry to the industry; where all firms produce an identical product; and where all firms are price taker.

Monopoly:  A market structure where there is only one firm in the industry.

Monopolistic competition:  A market structure where like perfect competition, 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.

Oligopoly:  A market structure where there are few enough firms to enable barriers to be erected against the entry of new firms.

Imperfect competition:  The collective name for monopolistic competition and oligopoly.

The short run under perfect competition:  The period which there is too little time for new firms to enter the industry.

The long run under perfect competition:  The period of time which is long enough for new firms to enter the industry.

Natural monopoly:  A situation where long-run average costs would be lower if an industry were under monopoly than if it were shared between two or more competitors.

Competition for corporate control:  The competition for the control of companies through takeovers.

Perfectly contestable market:   A market where there is free and cost-less entry and exit.

Sunk costs:  Costs that cannot be recouped (eg:  by transferring assets to other uses).

Chapter 12: Profit maximization under imperfect competition.

Independence (of firms in a market):  When the decisions of one firm in a market will not have any significant effect on the demand curves of its rivals.

Product differentiation:  When one firm's product is sufficiently different from its rivals' to allow it to raise the price of the product without customers all switching to the rivals' products.  A situation where a firm faces a downward-sloping demand curve.

Collusive oligopoly:  When oligopolists agree, formally or informally, to limit competition between themselves.  They may set output quotas, fix prices, limit product promotion or development, or agree not to 'poach' each other's market.

Non-collusive oligopoly:  When oligopolists have no agreement between themselves - formal, informal or tacit.

Cartel:  A formal collusive agreement.

Quota (set by a cartel):  The output that is given member of a cartel is allowed to produce (production quota) or sell (sales quota).

Tacit collusion:  A situation where firms have an unspoken agreement to engage in a joint strategy.  For example, oligopolists take care not to engage in price cutting, excessive advertising or other forms of competition.  There may be unwritten 'rules of collusive behaviour such as price leadership.

Dominant firm price leadership:  When firms (the followers) choose the same price as that set by a dominant firm in the industry (the leader).

Barometric firm price leadership:  Where the price leader is the one whose prices are believed to reflect market conditions in the most satisfactory way.

Average cost pricing:  Where a firm set its price by adding a certain percentage for (average) profit on top of average cost.

Price benchmark:  This is a price which is typically used.  Firms, when raising prices, will usually raise them from one benchmark to another.

Cournot model:  A model of duopoly where each firm makes its price and output decisions on the assumption that its rival will produce a particular quantity.

Duopoly:  An oligopoly where there are just two firms in the market.

Nash equilibrium:  The position resulting from everyone making their optional decision base on their assumptions about their rivals' decisions.

Takeover bid:  Where one firm attempts to purchase another by offering to buy the shares of that company from its shareholders.

Kinked demand theory:  The theory that oligopolists face a demand curve that is kinked at the current price:  demand being significantly more elastic above the current price than below.  The effect of this is to create a situation of price stability.

Countervailing power:  When the power of a monopolistic / oligopolistic seller is offset by powerful buyers who can prevent the price from being pushed up.

Game theory (or the theory of the games):  The study if alternative strategies that oligopolists may choose to adopt, depending on their assumptions about their rivals' behaviour.

Maximin:  The strategy of choosing the policy whose worst possible outcome is the least bad.

Maximax:  The strategy of choosing the policy which has the best possible outcome.

Dominant strategy game:  Where different assumptions about rivals' behaviour lead to the adoption of the same strategy.

Prisoners' dilemma:  Where two or more firms (or people), by attempting independently to choose the best strategy, based upon what other(s) are likely to do, end up in a worse position than if they had cooperated from the start.

Tit-for-tat:  Where a firm will cut prices, or make some other aggressive move, only if the rival does so first.  If the rival knows this, it will be less likely to make an initial aggressive move.

Credible threat (or promise):  One that is believable to rivals because it is in the threatener's interests to carry it out.

Decision tree (or game tree):  A diagram showing the sequence of possible decisions by competitors firms and the outcome of each combination of decisions.

First-mover advantage:   When a firm gains from being the first one to take action.

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