Theory of the firm

• Time periods?


  if a firm wants to icnrease output it needs to icnrease its inputs, but these cannot be varied with equal ease.

  Labour is easier to vary than machinery
• Short run?


  period of time when one or more factor of production is faxed, which is usually an element of capital or land
• long run?


  eriod in which all factors of production can be varied, within the confines of given technology
• very long run?


  all factors of production and technology can be varied
• total product?


  total quantity of output produced by a given number of inputs, in a particular time period
• average product?


  the quantity of output per unit

  total product/ quantity of units
• marginal product?


  addition to output produced by an extra unit of input

  change in total product/ change in quantity of inputs
• law of diminishing returns/ variable proportions?

  when increasing quantities of a variable factor (usually labour) of production ar eused in combination with another fixed factor (usually capital) intiallt the AP and MP will rise but eventually they will decline
• reason for law of diminishing returns?

  the intial icnrease in productivity occurs due to the use of specialisation and eventual decline in productivity occurs due to overcrowding of fixed factors of production
• Diminishing returns graph?


  The MP reaches a max first, then AP then TP

  The MP intersects the AP at the APs max point

  They all decline

  The MP becomes negative at the point when the TP is at max,

  Diminishing marginal returns occurs before diminishing average returns
• fixed costs?


  costs that do not vary with output in short run eg rent, machinery, insurance
• variable costs?


  costs that vary proportionately with output eg wages and raw materials
• total costs?


  in short run: FC + VC
• How is the LRAC curve typically shaped?

  A bucket like shape with three sections: increasing returns to scale, constant returns to scale and decreasing returns to scale

  eg increasing: % change in output is larger than % change in inputs
• Minimum efficient scale?


  the lowest level of output required to exploit full economies of scale- occurs jsut before constant returns to scale on LRAC curve.
• Economies of scale?


  A reduction in LRAC as output increases

  interal- occurs within business control

  external- occurs outside the business control, but within the industry
• economies of scale equation

  internal: AC= small total cost increase divided by an even larger output growth

  external: AC= decreasing total cost divided by output
• internal economies of scale?

  Risk bearing- can be spread over larger output

  Financial- negotiate lower interest

  Managerial

  Technical- specialist machines

  Marketting- bulk advertising

  Purchasing- bulk buy raw materials
• external economies of scale?

  better transport infrastructure

  Component suppliers move close— decreases transport costs

  Research and development firms mvoe closer
• Diseconomies of scale?


  AC= TC increase divided by smaller increase in quantity

  Control

  Communication

  Coordination

  Motivation
• Shift of LRAC?


  An upward shift means higher average costs, and is caused bu an increase in factor prices, indirect taxes and external diseconomies of scale

  A downward shift means lower average costs, caused by lower factor inputs and indirect taxes, improvements in tehcnology and external economies of scale
• Internal vs external on graph?

  An internal economy of scale causes a movement along the LRAC

  An external economy of scale causes a shift in the LRAC

  If asked, discuss both changes
• Economies of scale?


  Occurs when the cost of expansion are less than the benefits so is positive for a firm
• Diseconomies of scale?


  Occurs when the cost of expansion is greater than the benefits so is negative for a firm
• LRAC and SRAC interaction?

  LRAC 'envelopes' multiple SRACs

  Initally, SRATC mvoe along the curve due to specialisation.

  The SRATC then shifts as it moves along the lRAC

  Look at powerpoint for this
• Technical economies?


  The reduction in cost due to changes in production techniques. They are internal.

  Includes: invisibilties, principle of increased dimensions, economies of linked processes, division of labour, maintenance
• Invisibilities?


  Certain production techniques can only be used if output is large enough, as machines have a certain level of capacity.

  It only becomes worthwhile to apply the most efficient productive techniques if output exceeds a minimum level dictated by the capacity of the technique
• Principle of increased dimensions?

  the capacity of a container increases more than proportionately to the quantity of material used to construct it.

  A fourfold increase in material raises capacity eightfold- applies to container ships, oil tankers and HGVs.

  A larger vehicle has higher purchase and running costs but less than the additional benefits of the load so unit costs fall
• economies of linked processes?

  for most of the production process several machines are needed but will have different production capacities. A larger firm can more likely use all machines at full capacity by employing more machines with low capacity. can doubel output without doubling inputs
• division of labour?


  the larger to firm the more people it employs, so the more opportunties for specialisation and division of labour. Therefore wages may rise but output icnreases more than proportionately
• Maintenance?


  becomes more efficient with specialist maintenance teams now available so less downtime when issues occur. Means higher levels of output so reduced unit costs
• Managerial economies?


  the level of opportunities for division of labour and the employment of specialist skills at management level.

  Includes: opportunities to employ specialist managers and ability to offer better pay and benefits
• Opportunities to employ specialist managers?

  most big firms have divisions and various departments. Also training and development of staff can be formal and more extensive. Means employees are more efficient and ouput will increase proportionately more than costs.
• Ability to offer better pay and benefits?

  pay and benefits can be more generous allowing larger firms to have the first pick of potential applicants. Recruitment can employ hgiher calibre of staff easier due to a profit related pay, better caeer structure, other benefits.

  More skilled staff raises efficiency and leads to output increasing proportionately more than costs
• Marketing economies?


  due to further application of specialisation in the buying and sellign process.

  Includes: bulk buying/ purchasing economies, advertising, product development, distribution, marketing specialists
• Purchasing economies/ bulk buying?

  discounts are given with large orders as suppliers experience a cost saving in dealing with fewer bulk orders than many small ones. Savings are also made on administration and delivery costs.

  Bigger firms have a better bargaining position- their orders are very important to their suppliers.

  This could also be seen as a technical economy as it looks at factor costs.
• Economies in advertising?


  promotion becomes more viable the larger the output, the larger the market and the more cost effective promotions such as advertising are. Similarly, a larger firm has a better known and more trusted brand name
• Product development?


  Costly and time consuming. Marketing and R and D departments are more viable the larger the businesses as it can support a greater overhead so is more liekly to improve its productivity
• Distribution?


  becomes more efficient as bulk transport systems become justified and fully utilised
• Employing marketing specialists?


  buyers, marketing managers etc, should lead to higher output levels