Theory of the Firm Flashcards

Only 10 flashcards are shown at a time! Once you’ve mastered these 10 Economic terms, click the shuffle button below for 10 new terms. There are approximately 45 flashcards covering Theory of the Firm

Productive efficiency
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When a good is produces in the least cost manner, productive efficiency is achieved. This means that firms producing the good are achieving the lowest possible average production cost; in other words, they are producing at the lowest point on their average total cost curve, where marginal cost intersects the ATC. Among the four market structures (perfect competition, monopolistic competition, oligopoly and monopoly), only perfectly competitive firms will achieve productive efficiency in the long-run, since the price in the market will always be competed down to the firms’ minimum ATC.

Productive efficiency
Economic profit
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Also called “abnormal” profit. This is the revenues earned by a firm beyond that which is needed to cover all explicit costs (wages, rent and interest) and what the business owner expects to earn (normal profit). Entrepreneurs are attracted to industries in which economic profits can be earned.

Economic profit
Total Revenue
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What a firm earns from the sale of its output. Equals the price of the output multiplied by the quantity sold.

Total Revenue
Monopolistic Competition

A market in which a relatively large number of firms competes with one another by differentiating their products from the competition. Economic profits can be earned in the short-run through successful product differentiation, but due to the low barriers to entry they are unlikely in the long-run. Monopolistic competition is the most common market structure, and included restaurants, automobiles, clothes, salons, etc…

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Monopolistic Competition
Diseconomies of scale
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When a firm gets “too big for its own good”. If a firm expands beyond a certain size, it begins experiencing inefficiencies that cause its average costs to rise as output increases.

Diseconomies of scale
Total Product
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The total output of a firm.

Total Product
Oligopoly
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A market in which a relatively small number of firms compete with one another in a strategic manner. Characterized by a strong interdependence between the small number of firms. Barriers to entry are high and firms are hesitant to change their prices due to the fact that price wars may result when prices are lowered, and significant market share can be lost if prices are raised. Such markets tend to be highly inefficient due to the lack of competition.

Oligopoly
Cartel
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When oligopolistic sellers agree to act together to restrict output and raise the price, essentially producing at the monopoly level of output.

Cartel
Indirect Taxation
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Taxes placed on consumption. Considered indirect because households only pay them when they buy a good, compared to a direct tax on their income.

Indirect Taxation
Fixed Costs
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Costs which do not change with the level of output in the short-run. Fixed costs must be paid regardless of the level of output. For example rental payment and interest payments on a bakery remain the same regardless of whether the bakery makes 10 muffins or 10,000 muffins. These costs are fixed.

Fixed Costs

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