Micro & Macro Essay Plans
A. Home Farm is one of many small firms producing lettuces and attempting to maximise profits.
https://zahablog.files.wordpress.com/2010/05/aqa3jan10ms.pdf
1. Explain the circumstances in which Home Farm might make supernormal profits in the short
run, but only normal profits in the long run.
Supernormal profits: all the excess profit a firm makes above the minimum return necessary to keep a firm in business. –
calculated by Total Revenue – Total Costs (where total cost includes all fixed and variable costs, plus minimum income
necessary for the owner to be happy in that business.)
Normal profits: minimum level of profit necessary to keep a firm in that line of business. This level of normal profit enables
the firm to pay a reasonable salary to its workers and managers. – Occurs when AR=ATC
Conditions for perfect competition:
Perfect competition: is a description of how a market would work if certain conditions were satisfied.
- There’s an infinite number of suppliers and consumers.
- Consumers AND producers have perfect information
- Products are identical (homogeneous).
- There are no barriers to entry and no barriers to exit.
- Firms are profit maximisers
Point 1:
Home Farm is being one of many, small firms
Lettuces possibly being an homogenous product/ having no brand name
Other conditions that would need to be fulfilled, e.g. freedom of entry and exit, perfect knowledge
Whether the firm sells to one large customer or to many smaller ones
The conditions for a perfectly competitive market ensure that the rationing, signalling and incentive functions of the price
mechanism work perfectly. In particular:
all firms are price takers (‘the market’ sets the price according to consumers’ preferences, rationing resources
and signalling priorities),
consumers and producers have perfect knowledge of the market, and there are no barriers to entry or exit (so
firms can recognise and act on incentives to change their output level or enter/leave a market).
In SR, if firms become aware of other firms earning supernormal profits (they know bc of perfect information), they will
enter the market easily – low barriers to entry.
increases supply in the market, and price is reduced. This happens only up to the point at which only normal profit is
made, meaning only the most competitive firms will survive in the market. In SR: possible for a firm = loss, normal profit,
supernormal.
Point 2:
, Micro & Macro Essay Plans
Firms are only able to make normal profits in the long run. Any supernormal in SR; will encourage firms to enter market
(increasing market supply) & firms making losses will leave the market.
In the long run, firms are productively & allocatively efficient.
- Productive efficiency: where firms produce at the lowest point on the ATC curve (X) P = MC = AC = MR = AR
- Allocative efficiency: P = MC, meaning that the price consumers pay = the cost of producing the last unit of good.
optimum allocation of resources.
There is perfect information in this market. Also, there are no barriers to entry.
short run is a time period where at least 1 factors of production is fixed. for example land.
Abnormal profits occur in short run when AR>AC.
From the diagram, a firm takes market price in the short run. This price is at P, determined by the market/industry. The
firms then allocates where MC = MR, where profit is maximised and they are making abnormal profits (this is because each
incremental benefit=incremental cost. The firm has made all excess profits and does not produce more where it will make
excess loss).
At this point, the total revenue is represented by PxQ. At the same output, AC<AR. This means that the total cost, which is
AC.Q is less than total revenue. The excess revenue is the abnormal profit.
IN the long run, as the firms are making abnormal profits, more firms can enter the market because there is low barriers to
entry.
therefore they increase supply of the industry, and push price downwards. There is a downward shift of the AR curve.
Assuming that the firms continue to produce where MC=MR, the output is changed from Q to Q1, hence, firms make a
normal profit where AC=AR
- In SR; firms takes market price at AR.
They allocate at MC=MR, the firms
make a abnormal profit. This occurs at
AR>AC.
- In LR; due to absence of barriers entry,
new firms enter as they are
incentivized by abnormal profits. The
supply in the market increases and
hence AR shifts down. AR=AC, normal
profit
, Micro & Macro Essay Plans
In the long run, it may lead to the possibility of a contestable market.
Contestable market: a market with freedom of entry and exit.
2. Evaluate the argument that managers controlling large companies might follow policies which do not
necessarily maximise the profits of the owners.
Introduction:
traditional theory of the firm states: firms aim for profit maximisation
Profit Maximisation:
In reality: other objectives, eg. Sales maxm / revenue maxm – or social, environmental issues etc
P1:
aiming for other objectives may reduce profit in the SR.
A firm aiming to maximise profit will operate at output level Q, where MR = MC.
- Firms that are aiming for other objectives will operate at different output
levels
Maximising revenue = producing where MR = 0
1) Revenue is maximised when MR = 0.
2) This happens at output level Q1 — a higher output than Q.
3) If a firm is aiming to maximise revenue they will keep
increasing output past the point where profit is maximised, as long as adding more output leads to greater revenue.
Maximising sales = producing where AR = AC
1) A firm aiming to maximise sales will produce at an output level where AR = AC.
2) This is the highest level of output the firm can sustain in the long run.
3) Q2 is the sales-maximising output level — it’s higher than Q and Q1.
4) If sales increased further the firm would be making a loss
Or they may want to increase their market share
- A large market share could lead to monopoly power —firm could charge higher prices (lack of competition.)
• Bigger firms are often considered more prestigious and stable, so they can attract the best employees.
P2: Maximising Profit might only be an objective in the LR
1) Maximising profit in LR sometimes means sacrificing profit in SR.
2) A firm may try to maximise sales or revenue in SR, e.g. a firm might maximise revenue or sales to increase its market
share, or to gain monopoly power so that it can make supernormal profits in LR.
3) Some firms may even be willing to operate at a loss in SR in order to make a profit in LR.
A firm may expect revenue to increase in future, once they’ve been in the market for a while and brand recognition
increases. Or a firm might expect to reduce costs when they’re able to output at higher production levels (i.e.
experience economies of scale), and so they may keep operating at a loss while they build up the business.
A. Home Farm is one of many small firms producing lettuces and attempting to maximise profits.
https://zahablog.files.wordpress.com/2010/05/aqa3jan10ms.pdf
1. Explain the circumstances in which Home Farm might make supernormal profits in the short
run, but only normal profits in the long run.
Supernormal profits: all the excess profit a firm makes above the minimum return necessary to keep a firm in business. –
calculated by Total Revenue – Total Costs (where total cost includes all fixed and variable costs, plus minimum income
necessary for the owner to be happy in that business.)
Normal profits: minimum level of profit necessary to keep a firm in that line of business. This level of normal profit enables
the firm to pay a reasonable salary to its workers and managers. – Occurs when AR=ATC
Conditions for perfect competition:
Perfect competition: is a description of how a market would work if certain conditions were satisfied.
- There’s an infinite number of suppliers and consumers.
- Consumers AND producers have perfect information
- Products are identical (homogeneous).
- There are no barriers to entry and no barriers to exit.
- Firms are profit maximisers
Point 1:
Home Farm is being one of many, small firms
Lettuces possibly being an homogenous product/ having no brand name
Other conditions that would need to be fulfilled, e.g. freedom of entry and exit, perfect knowledge
Whether the firm sells to one large customer or to many smaller ones
The conditions for a perfectly competitive market ensure that the rationing, signalling and incentive functions of the price
mechanism work perfectly. In particular:
all firms are price takers (‘the market’ sets the price according to consumers’ preferences, rationing resources
and signalling priorities),
consumers and producers have perfect knowledge of the market, and there are no barriers to entry or exit (so
firms can recognise and act on incentives to change their output level or enter/leave a market).
In SR, if firms become aware of other firms earning supernormal profits (they know bc of perfect information), they will
enter the market easily – low barriers to entry.
increases supply in the market, and price is reduced. This happens only up to the point at which only normal profit is
made, meaning only the most competitive firms will survive in the market. In SR: possible for a firm = loss, normal profit,
supernormal.
Point 2:
, Micro & Macro Essay Plans
Firms are only able to make normal profits in the long run. Any supernormal in SR; will encourage firms to enter market
(increasing market supply) & firms making losses will leave the market.
In the long run, firms are productively & allocatively efficient.
- Productive efficiency: where firms produce at the lowest point on the ATC curve (X) P = MC = AC = MR = AR
- Allocative efficiency: P = MC, meaning that the price consumers pay = the cost of producing the last unit of good.
optimum allocation of resources.
There is perfect information in this market. Also, there are no barriers to entry.
short run is a time period where at least 1 factors of production is fixed. for example land.
Abnormal profits occur in short run when AR>AC.
From the diagram, a firm takes market price in the short run. This price is at P, determined by the market/industry. The
firms then allocates where MC = MR, where profit is maximised and they are making abnormal profits (this is because each
incremental benefit=incremental cost. The firm has made all excess profits and does not produce more where it will make
excess loss).
At this point, the total revenue is represented by PxQ. At the same output, AC<AR. This means that the total cost, which is
AC.Q is less than total revenue. The excess revenue is the abnormal profit.
IN the long run, as the firms are making abnormal profits, more firms can enter the market because there is low barriers to
entry.
therefore they increase supply of the industry, and push price downwards. There is a downward shift of the AR curve.
Assuming that the firms continue to produce where MC=MR, the output is changed from Q to Q1, hence, firms make a
normal profit where AC=AR
- In SR; firms takes market price at AR.
They allocate at MC=MR, the firms
make a abnormal profit. This occurs at
AR>AC.
- In LR; due to absence of barriers entry,
new firms enter as they are
incentivized by abnormal profits. The
supply in the market increases and
hence AR shifts down. AR=AC, normal
profit
, Micro & Macro Essay Plans
In the long run, it may lead to the possibility of a contestable market.
Contestable market: a market with freedom of entry and exit.
2. Evaluate the argument that managers controlling large companies might follow policies which do not
necessarily maximise the profits of the owners.
Introduction:
traditional theory of the firm states: firms aim for profit maximisation
Profit Maximisation:
In reality: other objectives, eg. Sales maxm / revenue maxm – or social, environmental issues etc
P1:
aiming for other objectives may reduce profit in the SR.
A firm aiming to maximise profit will operate at output level Q, where MR = MC.
- Firms that are aiming for other objectives will operate at different output
levels
Maximising revenue = producing where MR = 0
1) Revenue is maximised when MR = 0.
2) This happens at output level Q1 — a higher output than Q.
3) If a firm is aiming to maximise revenue they will keep
increasing output past the point where profit is maximised, as long as adding more output leads to greater revenue.
Maximising sales = producing where AR = AC
1) A firm aiming to maximise sales will produce at an output level where AR = AC.
2) This is the highest level of output the firm can sustain in the long run.
3) Q2 is the sales-maximising output level — it’s higher than Q and Q1.
4) If sales increased further the firm would be making a loss
Or they may want to increase their market share
- A large market share could lead to monopoly power —firm could charge higher prices (lack of competition.)
• Bigger firms are often considered more prestigious and stable, so they can attract the best employees.
P2: Maximising Profit might only be an objective in the LR
1) Maximising profit in LR sometimes means sacrificing profit in SR.
2) A firm may try to maximise sales or revenue in SR, e.g. a firm might maximise revenue or sales to increase its market
share, or to gain monopoly power so that it can make supernormal profits in LR.
3) Some firms may even be willing to operate at a loss in SR in order to make a profit in LR.
A firm may expect revenue to increase in future, once they’ve been in the market for a while and brand recognition
increases. Or a firm might expect to reduce costs when they’re able to output at higher production levels (i.e.
experience economies of scale), and so they may keep operating at a loss while they build up the business.
