Notes of the theory of the firm, with detailed information on economies of scale, diseconomies of scale, average revenue, average cost, barriers to entry, barriers to exit and efficiencies.
Public goods
Public goods - goods that are consumed collectively which are non-excludable and nonrival e.g., lamppost, defence
Non-excludability - individuals cannot be excluded from consuming it even if you haven’t paid for it
Non-rival - when an individual consumes the good, it doesn't impact somebody else's consumption.
Non-rejectable - collective supply means that it can’t be rejected by people
Pure public good - all the features
Free rider problem - people don’t consume the good because they rely on someone else paying for it and them
benefiting from it - missing market.
Theory of the firm 1
Marginal Utility
Marginal principle - economic agents will make decisions by considering the effects of small changes from existing
situations.
Concept of marginal utility - the additional utility gained from consuming an extra/ 1 more unit of a good or service.
Law of diminishing marginal utility - as the number of units consumed increases, the utility derived from each
additional unit of consumption decreases
Marginal utility curve:
Marginal utility reflects the value an individual places on a good or service - if this price is higher than the marginal
utility - a rational consumer would not consume the good
The equi-marginal principle
Equi-marginal principle - (rearrange)
The ratio of utility between goods is higher or equal to the ratio of the price between two goods - rational consumers
would buy the good.
Equi-marginal principle may not hold - not all consumers are rational - inertia - impulse buying - very subjective and
arbitrary to measure utile for a good - difficult to measure accurately - consumer may not know how much
satisfaction they will receive before consuming it.
Costs in the short-run
Fixed costs - doesn’t change with output e.g., rent, wages with a fixed contract
Variable costs - costs that vary with output e.g., electricity bills, prices of raw materials
Total cost (TC) - total fixed costs + total variable costs
Average cost (AC) - total cost/ output - cost per unit
Average fixed cost - fixed cost/ output
Average variable cost - variable cost/ output
Marginal cost - change in total cost of producing one more unit of output
Short-run - when at least one F.O.P is fixed
Long-run - all F.O.P are variable - can alter any F.O.P (some labour costs e.g., zero hour contract are variable)
, Law of diminishing returns - as the input of a variable factor is increased e.g., labour - the additional output produced
by each additional unit of input falls - therefore the short run average cost increases
SRAC curve:
Initially they fall as the fixed cost spreads over more units of output but then average cost starts rising as diminishing
returns sets in.
Theory of the firm 3: Costs in the long run - economies of scale
Internal economies of scale - a decrease in the firm’s long run average cost as a result of its level of its output
increasing
Economies of scale:
Bulk buying - as firms expands - buy more supply in bulk as it is cheaper e.g., Tesco buys potatoes from
suppliers in bulk - supplier is reliant on large supermarkets e.g., Tesco - costs likely to be lower - larger supply
- larger output - smaller cost spread over a larger output - lower LRAC
Technological economies of scale - as firms expands - can benefit from investing in advanced capital -
increase productivity and makes less mistakes - lower costs spread over a larger unit of output - lower LRAC -
e.g., Tesco is more likely to invest in self-checkouts to reduce its LRAC whereas a corner shop cannot do so
Managerial economies of scale - as firms expand - able to hire more specialised workers - managerial skills
makes other workers more skilled too - higher output per worker per hour and less likely to make mistakes -
lower cost spread over a higher output - lower LRAC
Financial economies of scale - banks more likely to give out loans at a lower interest rate to larger companies
- less risky to lend out loans since firms have a lot of collateral - lower repayments - able to use loans to
invest in capital for example - expand output - lower cost spread over a higher output reduces LRAC e.g.,
Tesco more likely to take out loans at a lower interest rate than a small shop
Marketing - as firms expands - cost of advertising is lower in proportion to output - e.g., Tesco’s cost of
advertising is much lower relative to their high output whereas smaller supermarket that sells leaflets as that
takes up a larger proportion of their profits and is spread over a small output - Tesco’s lower cost of
advertising is spread over a large output (that is expanded from marketing) - lower LRAC
Risk bearing - as firms expand and increase their output - can diversify into different industries - e.g., Tesco is
expanded into Tesco Mobile and Tesco exchange - if one industry fails, the firm can rely on other industries
hence the output will remain high - cost is spread over a much larger output - lower LRAC
Internal diseconomies of scale:
Coordination problems - cost can become too big for a firms to manage different departments - high
managerial cost and lower output due to mistake being made and a lack of organisation and lose track of
efficiency and productivity - e.g., British Airways has checkouts across the work, which can be costly to
manage - higher cost spread over a lower output - higher LRAC
Worker productivity - large firm - workers may feel insignificant and not recognised - lose moral and become
complacent - lose productivity - output per worker per hour decreases - more likely to make mistakes -
higher cost spread over a lower output - higher LRAC
Slow decision making - as a firm expands - many layers of management - cause lack of communication - firms
cannot quickly switch factors of production to a sector where there’s high demand due to lack of
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