Econ T2

Anchoring

Relying on the first piece of information offered

Framing

Influenced by how information is presented

Bounded rationality

Rationality is limited by cognitive limitations and time available for decision → satisfactory option is made over optimal

Bounded self-control

Self control is unavailable with some decisions → purchasing goods, even though the law of diminishing marginal utility is in place

Bounded selfishness

A concern for the well-being of other others (eg charity)

Imperfect information

Person lacking information needed to make a decision

What are heuristics and when are they used?

They are mental shortcuts and used when there is limited time information and mental capacity

Availability bias

Decision-making influenced by information that comes readily to mind often based on previous experiences

Choice architecture

Layout, sequence and range of goods of a firm influencing the consumers decision-making process

Default choice

Normal course of action

Restricted choice

Based on bounded rationality. Too many choices and too little time to work throughout the alternatives

mandated choice

Required by law to choose

What is the nudge theory

The nudge theory suggests that small changes in how choices are presented can influence peoples behaviour without restricting freedom

E.g. Choice architecture, setting the medium size as standard so people can upsize, limited stock labels to increase pressure and psychologically decrease peoples’ time available to make the decision.

Business objectives of producers are

Profit maximisation, corporate social responsibility (CSR), market share, satisficing and business growth.

Profit maximisation

Business decision-making is guided primarily by the entrepreneurs desire to achieve the highest possible profit

Profit is the reward entrepreneurs earn from taking the risk of starting up a business

Corporate social responsibility (CSR)

Set of business objectives regarding environmental social and ethical factors. Environmental objectives are often set up due to government regulations.

Often for agricultural or energy industries or production can have a significant impact on the environment.

Mini firms also adapt these objectives, please stakeholders

Market share

Market share is the percentage of total market revenue and individual firms revenue accounts for.

It calculated as: individual firms TR / the markets TR x100

Market shares in effective measure for the relative performance, regardless of market condition → affirm might experience a decrease in revenue but its performance might still be good if total market sales also decrease (recession)

A strong market share position might allow a firm to influence market price have promotional power over consumers and the greater bargaining power with suppliers.

Satisficing

Aiming for satisfactory over optimal

Instead of maximising profits a firm sets an acceptable profit goal → comfortable living

Satisfying might give better quality of life, but with an opportunity cost in terms of lower wage and profits.

Business growth

Growing profit revenue and market share is a key objective for many firms because it represents progress

More customers more countries and higher asset value is often considered successful in terms of growth

The business growth is linked with profit maximisation it is not quite the same → affirm may look to discount its products to achieve sales growth at the expense of short-term profit.

what are implicit costs

implicit costs is the opportunity cost(s) that exist in every business decision-making situation. Choosing between alternatives.

what are explicit costs

the costs that firms incur in their operations.

they are a stated money value arising from the use of resources.

Explicit costs can me categorised in terms of FOP’s:

Capital→interest

Enterprise/entrepreneurship→ normal profit

Land→ rent

Labour→wages

Firms also incur in costs such as energy, administration and marketing in their normal course of business.

Short run is

a time period where at least one of the FOPs is fixed (usually capital) while others are variable. Firms operate in the short-run which is also called the production stage. Buildings (land) is often hard to change in the short-run and are thus called fixed factors.

Long-run is

a time period where all FOPs are variable, which can also be expressed as a firm being able to vary bot labour and capital. Firms CANNOT operate in the long-run, which is also called the planning stage.

What is the Theory of Product

a quantitative way to express a firms output in the SR

The three ways to measure a firms product are

Total Product (TP), Marginal Product (MP), Average Product (AP)

Total product is

the total output a firm can produce from a given quantity of labour and capital inputs

Marginal product is

the change of TP when one extra unit of labour or capital is added (change in TP/ change in labour or capital input)

Average product is

output per unit of labour or capital input (TP/labour or capital input)

What is the Law of Diminishing Returns (my acronym: LDR)

The Law of Diminishing Returns states that whena variable factor such as labour is added to a given set of fixed factors, such as capital, there is a point where the MP of the extra unit of variable falls (or diminishes)

When does maximum efficiency occur

MP=AP , also the point AP_max

beyond this point the dimnishing marginal returns set in.

NOTE: as long as MP>AP, even if it is falling, each additional worker is increasing AP. If MP<AP each additional worker is decreasing AP.

In the theory of cost, costs can be categorised by

Total cost, Average Totacl cost and Marginal cost

Total cost is

the total cost (TC) of producing a set quantity of output. It includes the costs of FOPs used

Average Total Cost (ATC)

the cost per unit of output at a set quantity (Q)

Calculated: TC/TP =ATC

Marginal cost (MC)

charge in TC when one more unit of output is produced

Calculated: change in TC/change in Q (or ΔTC/ΔQ) = MC

Why does the law of diminishing returns only affect variable costs?

The law of diminishing returns only affects variable costs because these are costs that change with output.

Whena firm starts production the MP and AP will initally rise → the MC and ATC will initially drop. However as the law of diminishing returns sets in, both MP and AP will fall → MC and ATC will increase.

The curves of MC and ATC are U-shaped due to the law of diminishing returns.

Explain how the supply curve is determined by the MC curves of the (firms in the) market

The supply curve is determined by the MC curves of all firms in the market. This is called horizontal summing, which means the market supply is derived by adding together all the marginal supply curves of firms in the market

→ this means that the law of diminishing returns determines the upward-sloping nature of the market supply curve.

Why can the importance of the law of diminishing returns be arguable to many firms?

Are the existence of the law of diminishing returns is very real the importance of it to many firms is arguable.

Enlarge manufacturing organisations or labour is a small proportion of the total, diminishing returns have minimal effect on unit costs.

Which assumption does the product theory make in terms of labour?

Product theory assumes all labour is equally productive which is not the case in reality. Affirms marginal product might decrease if a less motivated and unproductive worker is added, however it’s marginal product might increase if a more motivated and productive worker is added.

Commercial economies

Arise from the ability of large firms to buy and sell in bulk. For example Walmart has great buying power and is able to negotiate low purchase prices from suppliers.

Technical economies

Occur because large firms can use large scale machinery that reduces unit costs. For example, Walmart moves its goods in large lorries which have lower per unit costs than moving goods in small vans.

Financial economies

Financial economies benefit large firms when they raise funds. Banks are willing to offer firms like Walmart lower interest rates because they represent a lower risk than small retailers.

Labour or managerial and economies

Labour or managerial economies arise because workers in large firms can specialise in particular tasks. Small firms have to divide their time between multiple functions.

Communication diseconomy

Occurred when firms become too big. As the number of employees, departments and offices increases it becomes increasingly hard for the managers to communicate with their employees.

Motivation diseconomies

Motivation disc economies arise as large firms find it harder to manage workers in organisations that they find more difficult to identify with.

For example, a person working for a small retailer might be more motivated than a person working for a big one such as Walmart.

Administrative diseconomies

Administrative economies are more likely to occur in large organisations where bureaucracy increases hindering the decision-making processes.

Break-even point

Loss making firms will shut down and exit the market in the long run however in the short run firms will often continue if they can cover their fixed costs.

It is identified with TR=TC or AR=ATC

What is perfect competition?

Perfect competition is a theoretical model of how a market behaves under the conditions of the purest form of competition.

There are no examples of pure, perfect competition however the characteristics of it can be observed in agricultural markets

Assumptions/characteristics of PC

A large number of small buyers and sellers

Homogenous products

No barriers to entry or exit

Perfect knowledge

a large number of small buyers and sellers

In a PC market, no single buyer or seller can influence the market price or output. For example, 1900 commercial farms in Australia grow and produce oranges because each individual firm only makes up a small fraction of market output they cannot affect the market output and price

Homogenous products

No differences between the goods and services produced by different firms. This means that the buying decision decisions of consumers are purely based on price.

no barriers to entry or exit

This means that the costs of setting up in the market are no higher than the normal cost of setting up in the market and there are no costs associated with leaving the market. However, firms in the market will only incur the normal cost of leaving the market when they shut down production.

Perfect knowledge

All agents in the market are aware of the prices being charged by all producers in the market. This means that no firm can charge a different price in the market without consumers or other firms in the market being aware of the different prices charged.

In terms of PC what does market price mean

In a perfectly competitive market demand and supply determine the market price and output. The demand curve in a market/industry is the sum of the demand curves of all the individual firms. In the same way,  the market supply curve is the sum of all marginal cost (MC) curves in a market.

IN PC, the market price is the price each firm charges/takes. If a firm were to charge more the quantity would simply drop to zero, because consumers can find an alternative supplier (because all goods are homogenous) 

This means that firms in PC are thus price takers and face perfectly elastic (horizontal) demand curves.

D=AR=MR

How to calculate total revenue

TR=P*Q

What is average revenue

revenue per unit of output sold by a firm

AR= TR/Q → AR=P

What is marginal revenue

change in TR when one more unit of output is sold

MR= ΔTR/ΔQ

Where is the profit maximising output

MC=MR (when MC is rising)

What is the short-run equilibrium

D=S, equilibrium in price and output in the industry.

SR equilibrium can change if firms in the market experience abnormal profits/losses

what is the long-run equilibrium

Similar to SR equilibrium, D=S, but firms are all making normal profits.

No abnormal profits/losses → no pressures on market prices and output to change.

What are abnormal profits?

abnormal profits are profits earned by a firm when the entrepreneur earns more than the minimum profit required to keep the firm in the industry.

Thus occurs when TR>TC

what happens in the market when firms start makin abnormal profits?

When new firms see others are making abnormal profits, they see this as an opportunity to make some abnormal profits themselves. They thus enter the market, increasing supply, which decreases the market price and leads to the abnormal profits earned by the existing producers to decrease as well. This continues until firms stop entering the market.

what are losses

Occur when TC>TR

Means that firms make less than normal profit and in the long run leave the market, decreasing supply and raising market price → profit for remaining firms returns to normal.

What is productive efficiency

achieved when all firms in the market produce where they achieve the highest output per unit of resource input → each firm produces at the profit maximising output at the minimum point of ATC.

Thus occurs at MC=min. ATC