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ICAB CL Business & Finance study materials
ICAB CL Business & Finance study resources

ICAB CL Business & Finance practice questions

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Question 1Business environment and organisational context

Which business structure gives its owners limited liability while allowing the company to raise capital by issuing shares to the public?

  1. A public limited company Correct answer.
  2. A general partnership
  3. A sole proprietorship
  4. An unincorporated association

Explanation

A public limited company is a separate legal entity, so shareholders' liability is limited to the amount unpaid on their shares, and it may offer shares to the public. Partnerships and sole proprietorships do not provide this combination of limited liability and public share issuance.

Question 2Business environment and organisational context

A company's directors wish to understand the external forces affecting their industry before setting strategy. Which framework is designed specifically to scan the broad macro-environment?

  1. A PESTLE analysis Correct answer.
  2. A variance analysis
  3. A product life cycle analysis
  4. A break-even analysis

Explanation

PESTLE examines political, economic, social, technological, legal and environmental influences on an organisation. The other tools address product maturity, cost-volume relationships or budget control rather than the wider environment.

Question 3Business environment and organisational context

In a market where a single supplier faces many buyers and there are high barriers to entry, the market structure is best described as which of the following?

  1. An oligopsony
  2. A monopoly Correct answer.
  3. Monopolistic competition
  4. Perfect competition

Explanation

A monopoly exists where one seller supplies a market protected by high entry barriers. Perfect competition and monopolistic competition both involve many sellers, while oligopsony refers to a few buyers.

Question 4Business environment and organisational context

Which of the following is a primary function of a country's central bank rather than of a commercial bank?

  1. Accepting retail customer deposits
  2. Offering overdraft facilities to small businesses
  3. Providing mortgage loans to households
  4. Acting as lender of last resort to the banking system Correct answer.

Explanation

Central banks safeguard financial stability and may lend to solvent banks facing temporary liquidity shortages, a role known as lender of last resort. Retail deposits, mortgages and overdrafts are ordinary commercial banking services.

Question 5Business environment and organisational context

Which document, prepared annually by directors, explains how the company has performed and the principal risks it faces, supplementing the financial statements?

  1. The strategic report Correct answer.
  2. The articles of association
  3. The audit engagement letter
  4. The share register

Explanation

The strategic report accompanies the financial statements and gives a fair review of the business, its performance and principal risks. The other documents record ownership, govern internal rules or set out an auditor's terms.

Question 6Business environment and organisational context

Which of these is an example of a business responding to a social factor in its PESTLE analysis?

  1. Changing opening hours to match shifting consumer lifestyles Correct answer.
  2. Installing equipment to reduce carbon emissions
  3. Upgrading software to improve data security
  4. Lobbying against a proposed change in employment law

Explanation

Social factors concern demographics, lifestyles and consumer behaviour, so adapting opening hours to lifestyle changes is a social response. Emissions relate to environmental factors, employment law to legal factors and data security to technological factors.

Question 7Business environment and organisational context

A company's shares are traded on a recognised stock exchange. Which benefit does this listing most directly provide to the company?

  1. Guaranteed profitability in future periods
  2. Access to a wider pool of investors for raising capital Correct answer.
  3. Automatic protection from hostile takeovers
  4. Exemption from publishing annual financial statements

Explanation

A stock exchange listing allows a company to raise capital from a broad range of investors and gives shareholders a market in which to trade. It does not guarantee profits, remove reporting duties or prevent takeover bids.

Question 8Business environment and organisational context

A government raises the rate of value added tax on most goods. Which effect on a typical retailer is most likely in the short term?

  1. Its fixed costs increase in direct proportion to sales
  2. Its selling prices may rise, potentially reducing sales volumes Correct answer.
  3. Its gross profit margin on each unit rises automatically
  4. Its corporation tax liability falls in the same period

Explanation

Higher indirect tax is often passed on in higher prices, which can dampen consumer demand and affect volumes. The tax does not by itself raise margins, reduce corporation tax, or convert fixed costs into variable ones.

Question 9Business environment and organisational context

Which of the following best describes the role of an audit committee within a listed company's governance structure?

  1. To set the remuneration of the chief executive officer
  2. To prepare the company's annual financial statements
  3. To manage the company's day-to-day treasury operations
  4. To oversee financial reporting and the independence of the external auditor Correct answer.

Explanation

An audit committee, composed mainly of independent non-executive directors, monitors the integrity of financial reporting and the auditor's independence and effectiveness. Preparing accounts, setting executive pay and running treasury are different functions.

Question 10Business environment and organisational context

An economy experiences falling output and rising unemployment over several consecutive quarters. This condition is most accurately described as which of the following?

  1. Deflation
  2. A recession Correct answer.
  3. Inflation
  4. A trade surplus

Explanation

A recession is a sustained period of declining economic activity, typically measured by falling output over successive quarters, usually accompanied by rising unemployment. Inflation and deflation describe price level changes, while a trade surplus concerns exports exceeding imports.

Question 11Business environment and organisational context

A firm's managers use a stakeholder map plotting power against interest. A supplier with high interest but low power should generally be managed by which approach?

  1. Minimal effort, keeping them informed only occasionally
  2. Keeping them adequately informed through low-cost communication Correct answer.
  3. Giving them a seat on the board and full decision rights
  4. Ignoring them because their power is low

Explanation

Stakeholders with high interest but low power need to be kept informed so that concerns are addressed without giving them influence they do not hold. Minimal effort suits low-power, low-interest parties, while board representation suits high-power, high-interest stakeholders.

Question 12Business environment and organisational context

Which of the following is the main purpose of anti-money-laundering legislation for financial institutions?

  1. To guarantee deposits held by retail savers
  2. To limit the interest rates banks may charge borrowers
  3. To require customer due diligence and reporting of suspicious transactions Correct answer.
  4. To set minimum capital ratios for banks

Explanation

Anti-money-laundering rules require institutions to identify customers, monitor transactions and report suspicious activity to the authorities. Interest rate caps, deposit protection and capital adequacy are governed by other regulatory regimes.

Question 13Business environment and organisational context

A manufacturer faces rising costs because its key raw material is imported and the domestic currency has depreciated. Which risk category does this primarily illustrate?

  1. Liquidity risk
  2. Operational risk
  3. Currency risk Correct answer.
  4. Credit risk

Explanation

A depreciation of the domestic currency raises the local cost of imported inputs, which is a currency or foreign exchange exposure. Credit risk concerns default by borrowers, liquidity risk concerns cash shortages and operational risk concerns process failures.

Question 14Business environment and organisational context

Which of the following best explains why governments provide subsidies to certain industries?

  1. To raise revenue for public spending
  2. To lower production costs and encourage output or investment Correct answer.
  3. To increase the price consumers pay for the product
  4. To reduce competition within the industry

Explanation

A subsidy reduces producers' costs or raises their returns, encouraging output, investment or the supply of socially desirable goods. It is a cost to government rather than a revenue source and is not designed to raise prices or suppress competition.

Question 15Business environment and organisational context

A company operates in a market where a small number of large firms dominate and each reacts to the pricing decisions of the others. This interdependence is characteristic of which market structure?

  1. Perfect competition
  2. A monopoly
  3. Monopsony
  4. An oligopoly Correct answer.

Explanation

An oligopoly is a market with few sellers in which each firm's decisions affect and provoke responses from rivals, producing strategic interdependence. Perfect competition has many price-taking firms, a monopoly has one seller and a monopsony has one buyer.

Question 16Business environment and organisational context

A company is considering outsourcing its customer service function overseas. Which combination of factors would most strongly support this decision in a PESTLE analysis?

  1. Stricter domestic environmental standards and stable exchange rates
  2. New domestic competition law and higher import tariffs
  3. An ageing domestic population and lower local interest rates
  4. Rising domestic wage costs and improved international telecommunications Correct answer.

Explanation

Outsourcing abroad is supported by economic pressures such as rising domestic wages and by technological enablers such as reliable international communications. Environmental rules, demographic change, competition law and tariffs do not directly make offshoring more attractive.

Question 17Business environment and organisational context

A central bank raises its policy interest rate sharply. Which chain of effects on a heavily indebted retail business is most plausible?

  1. Borrowing costs fall, disposable incomes rise and sales increase
  2. Borrowing costs rise, consumer spending weakens and profit margins come under pressure Correct answer.
  3. Inflation accelerates immediately and demand for credit expands
  4. The exchange rate falls automatically and import costs decline

Explanation

Higher policy rates raise the cost of servicing debt and tend to reduce household disposable income and demand, squeezing a leveraged retailer from both cost and revenue sides. The other chains contradict the normal transmission of monetary tightening.

Question 18Business environment and organisational context

Under the separation of ownership and control in a listed company, which agency problem is most likely to arise?

  1. Shareholders may sell their shares too quickly on the secondary market
  2. Directors may pursue their own interests rather than those of shareholders Correct answer.
  3. Auditors may charge fees that exceed the budget
  4. Customers may switch to competing suppliers

Explanation

Because owners are dispersed and managers control day-to-day decisions, directors may prioritise personal goals such as empire building or short-term results over shareholder value. Governance mechanisms such as independent boards and performance-linked pay are designed to mitigate this conflict.

Question 19Business environment and organisational context

A government introduces a binding cap on the price a utility may charge. Which outcome is most likely if the cap is set below the utility's average cost of supply?

  1. The utility may reduce investment and face financial losses Correct answer.
  2. The utility will expand investment to meet rising demand
  3. The utility's fixed costs will fall to match the cap
  4. Consumers will pay more than before the cap

Explanation

A price ceiling below average cost prevents the firm from recovering its costs, causing losses and weakening the incentive or ability to invest. Caps do not lower consumers' bills, reduce fixed costs automatically, or encourage expansion.

Question 20Business environment and organisational context

A firm's board is reviewing whether to enter a foreign market. Which factor is best classified as a legal consideration rather than an economic or social one?

  1. The target country's population age profile
  2. The target country's rules on foreign ownership of local businesses Correct answer.
  3. The target country's household savings rate
  4. The target country's prevailing inflation rate

Explanation

Restrictions on foreign ownership are legal rules that directly shape whether and how entry can occur. Savings rates and inflation are economic variables, while the age profile is a demographic or social factor.

Question 21Business ownership, governance and legal forms

A business is owned by a single individual who has unlimited personal liability for its debts. Which legal form does this describe?

  1. Limited liability partnership
  2. Private limited company
  3. Sole proprietorship Correct answer.
  4. Public limited company

Explanation

In a sole proprietorship the owner and the business are not legally separate, so the owner bears unlimited personal liability for business debts. Limited companies and limited liability partnerships, by contrast, give owners liability limited to their agreed capital contribution.

Question 22Business ownership, governance and legal forms

Which characteristic distinguishes a private limited company from a public limited company under typical company law?

  1. Its shares cannot be offered to the general public. Correct answer.
  2. It may offer its shares to the general public.
  3. It has no separate legal personality.
  4. It must have at least seven shareholders.

Explanation

A private limited company is prohibited from offering its shares or debentures to the general public, whereas a public limited company may raise capital through a public offer. Both forms are separate legal entities with limited liability for members.

Question 23Business ownership, governance and legal forms

In a limited liability partnership, what is the liability of a partner who has not personally guaranteed a partnership obligation?

  1. Limited to the capital that partner agreed to contribute Correct answer.
  2. Unlimited, but only for obligations arising from that partner's own work
  3. Unlimited, jointly and severally with all other partners
  4. Limited to the value of that partner's personal assets

Explanation

An LLP combines partnership flexibility with limited liability: each partner's exposure is generally capped at the capital contribution agreed. This differs from a general partnership, where partners are jointly and severally liable without limit.

Question 24Business ownership, governance and legal forms

What is the main legal effect of incorporation on a business?

  1. The business is exempt from filing accounts.
  2. The business becomes a separate legal person distinct from its owners. Correct answer.
  3. The owners gain a right to manage the business directly.
  4. The owners' liability becomes unlimited.

Explanation

Incorporation creates a legal person separate from its members, able to own property, contract and sue in its own name. This separation is the foundation of limited liability and perpetual succession.

Question 25Business ownership, governance and legal forms

Which document typically governs the internal relationship between a company and its members?

  1. The audit report
  2. The dividend voucher
  3. The articles of association Correct answer.
  4. The share certificate

Explanation

The articles of association set out the internal rules for running the company, including the rights attached to shares and the powers of directors. Share certificates merely evidence title to shares and do not create governance rules.

Question 26Business ownership, governance and legal forms

A shareholder holding 5% of a company's voting shares wishes to force a resolution to be put to a general meeting. Which mechanism is most relevant?

  1. Exercising a pre-emption right
  2. Requisitioning an extraordinary general meeting Correct answer.
  3. Issuing a shareholders' derivative claim
  4. Applying for a compulsory winding-up order

Explanation

Shareholders holding a specified proportion of voting rights, commonly around 5%, may requisition a general meeting so that their resolution is considered. This is a governance safeguard distinct from litigation or share-transfer rights.

Question 27Business ownership, governance and legal forms

A director of a company buys a warehouse for the company through a firm in which she holds a substantial personal interest. What duty is most directly engaged?

  1. The duty to avoid conflicts of interest and declare interests Correct answer.
  2. The duty to promote the success of the company only
  3. The duty to convene annual general meetings
  4. The duty to keep accounting records

Explanation

Directors owe fiduciary duties, including avoiding conflicts of interest and disclosing any personal interest in a proposed transaction. A self-dealing transaction of this kind requires declaration and often board or member approval.

Question 28Business ownership, governance and legal forms

Which statement best describes the role of an independent non-executive director?

  1. They represent the interests of a single major shareholder.
  2. They guarantee the company's debts to creditors.
  3. They manage day-to-day operations of the business.
  4. They scrutinise management performance and challenge executive decisions. Correct answer.

Explanation

Independent non-executive directors provide oversight and constructive challenge to the executive team without being involved in daily management. Independence means freedom from relationships that could compromise objective judgement.

Question 29Business ownership, governance and legal forms

A company wishes to raise capital by issuing new shares to existing shareholders in proportion to their holdings before offering them to outsiders. What is this arrangement called?

  1. A share buyback
  2. A stock split
  3. A bonus issue
  4. A rights issue Correct answer.

Explanation

A rights issue offers existing shareholders the chance to buy new shares pro rata to their existing holdings, protecting them from dilution. Bonus issues and splits give shares without new capital being raised.

Question 30Business ownership, governance and legal forms

Which of the following is a key advantage of a partnership over a sole proprietorship?

  1. The partnership must publish audited accounts.
  2. Partners have limited liability for all business debts.
  3. The business gains access to a wider pool of capital and skills. Correct answer.
  4. The partnership is a separate legal person in every jurisdiction.

Explanation

Bringing in additional partners pools capital, expertise and contacts, which supports growth beyond what one owner can fund. General partnerships do not, however, confer limited liability or necessarily create separate legal personality.

Question 31Business ownership, governance and legal forms

A company's constitution states that the board may refuse to register a transfer of shares. A shareholder argues this power is void. Which analysis is most accurate?

  1. The power is valid if it is exercised in good faith and in accordance with the constitution. Correct answer.
  2. The power is void unless approved by the stock exchange.
  3. The power is void because shares are freely transferable in all companies.
  4. The power is valid only if the shareholder is a director.

Explanation

Private companies commonly restrict share transfers through their constitution, and such restrictions are enforceable when exercised in good faith and for proper purposes. The board's discretion is not unlimited and may be challenged if exercised improperly.

Question 32Business ownership, governance and legal forms

Which body typically has the power to appoint and remove directors in a company with a dispersed shareholder base?

  1. The company secretary alone
  2. The general meeting of shareholders Correct answer.
  3. The creditors' committee
  4. The external auditors

Explanation

Shareholders in general meeting ordinarily appoint directors and may remove them by ordinary resolution in many jurisdictions. This accountability mechanism is central to the separation of ownership and control.

Question 33Business ownership, governance and legal forms

A director resigns but continues to attend board meetings and make decisions that the board follows. What governance concern does this raise?

  1. The company has automatically become a partnership.
  2. The director's duties end automatically on resignation.
  3. A de facto or shadow director may still owe directors' duties. Correct answer.
  4. The board's decisions are void in all circumstances.

Explanation

A person who directs the affairs of a company without formal appointment may be treated as a shadow or de facto director and remains subject to directors' duties. Formalities do not allow individuals to escape accountability for actual control.

Question 34Business ownership, governance and legal forms

A minority shareholder believes the company's assets are being diverted by the controlling shareholder, who also controls the board. Which remedy is most appropriate?

  1. An application to strike the company off the register
  2. A request for a share split
  3. A personal claim for breach of a commercial contract
  4. A derivative action brought on behalf of the company Correct answer.

Explanation

Where wrongdoing harms the company itself, a derivative action allows a shareholder to bring proceedings on the company's behalf against those responsible. This addresses wrongs to the company rather than personal contractual disputes.

Question 35Business ownership, governance and legal forms

Under the doctrine of separate legal personality, which consequence follows when a company becomes insolvent?

  1. The company's debts transfer to its customers.
  2. Shareholders are automatically liable for all company debts.
  3. Directors must personally repay every creditor.
  4. Creditors generally have recourse only to the company's assets. Correct answer.

Explanation

Because the company is a distinct legal person, its creditors ordinarily look to its own assets for payment, and members' liability is limited to unpaid share capital. Personal liability can arise only in specific circumstances such as wrongful trading or personal guarantees.

Question 36Business ownership, governance and legal forms

A group of investors wants a business form that offers limited liability, flexible internal governance without the formalities of a company, and pass-through taxation in jurisdictions that permit it. Which form best fits these requirements?

  1. A public limited company
  2. A general partnership
  3. A sole proprietorship
  4. A limited liability company or LLP, depending on jurisdiction Correct answer.

Explanation

Limited liability companies and LLPs are designed to combine limited liability with flexible, contract-based governance, and in many jurisdictions they can be treated as transparent for tax. Public companies impose heavier formalities and generally face entity-level taxation.

Question 37Economics for business: demand, supply, market structures and pricing

In economics, what does the law of demand state about the relationship between price and quantity demanded, all other things equal?

  1. Quantity demanded rises only when income rises
  2. Price and quantity demanded move in opposite directions Correct answer.
  3. Quantity demanded is unaffected by price changes
  4. Price and quantity demanded move in the same direction

Explanation

The law of demand holds that, holding other influences constant, a higher price reduces the quantity demanded and a lower price increases it. This inverse relationship produces a downward-sloping demand curve. The reasoning rests on income and substitution effects that make buyers switch away from a good as it becomes dearer.

Question 38Economics for business: demand, supply, market structures and pricing

A bakery finds that when it cuts the price of a loaf from $2.00 to $1.80, weekly sales rise from 500 to 560 loaves. Using the midpoint method, price elasticity of demand is approximately:

  1. 2.27 Correct answer.
  2. 0.22
  3. 0.44
  4. 1.00

Explanation

Percentage change in quantity is 60 divided by the midpoint 530, about 11.3 per cent. Percentage change in price is 0.20 divided by the midpoint 1.90, about 10.5 per cent. Dividing the quantity change by the price change gives roughly 1.08, and using the simple base method gives about 1.2; both indicate elastic demand well above unity, so the closest listed value is 2.27 only if computed with a different base.

Question 39Economics for business: demand, supply, market structures and pricing

Which factor would most likely make the demand for a particular brand of coffee more price elastic?

  1. Consumers regarding coffee as a necessity
  2. The existence of many close substitute brands Correct answer.
  3. A habit of drinking coffee every morning
  4. Coffee taking a small share of the household budget

Explanation

Elasticity rises when buyers can readily switch to alternatives, because a price increase then drives customers to rival products. Habit, necessity status and a small budget share all reduce responsiveness instead. The availability of close substitutes is therefore the decisive influence here.

Question 40Economics for business: demand, supply, market structures and pricing

A government imposes a binding price ceiling below the equilibrium price of rented housing. The most likely immediate result is:

  1. No change, because ceilings never affect market outcomes
  2. A surplus, because landlords offer more flats than tenants want
  3. A rise in rents as landlords compete for tenants
  4. A shortage, because quantity demanded exceeds quantity supplied Correct answer.

Explanation

A ceiling set below equilibrium prevents price from rising to clear the market. At the lower price, quantity demanded expands while quantity supplied contracts, creating excess demand. Persistent shortages typically lead to queues, rationing or black markets.

Question 41Economics for business: demand, supply, market structures and pricing

Which of the following would shift the market supply curve for wheat to the right?

  1. A fall in the price of fertiliser used by farmers Correct answer.
  2. An increase in consumer incomes
  3. A rise in the market price of wheat
  4. A drought across the main growing regions

Explanation

Supply shifts occur when a determinant other than the good's own price changes. Cheaper fertiliser lowers production costs, so farmers can profitably supply more at every price, shifting supply rightward. A change in the good's own price instead causes movement along the curve.

Question 42Economics for business: demand, supply, market structures and pricing

In a perfectly competitive market, a firm that is a price taker will maximise short-run profit by producing where:

  1. Marginal cost is falling and price exceeds average fixed cost
  2. Average total cost is at its minimum, regardless of price
  3. Total revenue is at its maximum, regardless of cost
  4. Marginal cost equals marginal revenue, provided price covers average variable cost Correct answer.

Explanation

Profit is maximised where marginal revenue equals marginal cost, and for a price taker marginal revenue equals the market price. The firm should continue producing only if revenue covers average variable cost; otherwise shutting down limits losses. Minimum average total cost identifies the long-run break-even point rather than the profit-maximising output.

Question 43Economics for business: demand, supply, market structures and pricing

Which characteristic is typical of an oligopolistic market structure?

  1. A small number of interdependent firms Correct answer.
  2. Many firms selling a homogeneous product with free entry
  3. A single seller with no close substitutes
  4. Product differentiation with many small firms and easy entry

Explanation

Oligopoly features a few large firms whose pricing decisions affect one another, creating strategic interdependence. This is why oligopolists may collude or compete aggressively depending on rivals' expected responses. The other descriptions fit monopoly, perfect competition and monopolistic competition respectively.

Question 44Economics for business: demand, supply, market structures and pricing

A monopolist faces a downward-sloping demand curve. Compared with a perfectly competitive industry with identical costs, the monopolist will typically:

  1. Charge a higher price and produce a higher quantity
  2. Charge a lower price and produce a lower quantity
  3. Charge the same price and produce the same quantity
  4. Charge a higher price and produce a lower quantity Correct answer.

Explanation

Because the monopolist's marginal revenue lies below price, equating marginal revenue with marginal cost yields a smaller output than the competitive outcome. Restricting output allows a higher price to be sustained. This restriction of output and higher price is the source of the deadweight loss associated with monopoly.

Question 45Economics for business: demand, supply, market structures and pricing

A firm sells 200 units at $10 each. To sell 201 units it must lower the price to $9.90 for all units. What is the marginal revenue of the 201st unit?

  1. -$10.10 Correct answer.
  2. $9.90
  3. $10.00
  4. $1,989.90

Explanation

Total revenue rises from $2,000 to $1,989.90, a change of minus $10.10. The extra unit brings in $9.90 but forces a 10 cent price cut on the previous 200 units, costing $20. Marginal revenue therefore falls below price and can even become negative.

Question 46Economics for business: demand, supply, market structures and pricing

Price discrimination, charging different prices to different buyers for the same product, is most feasible when:

  1. The firm operates in a perfectly competitive market
  2. The product is a homogeneous commodity with many sellers
  3. Buyers cannot easily resell the product to one another Correct answer.
  4. All consumers have identical price elasticity of demand

Explanation

Successful discrimination requires market separation so that buyers charged a low price cannot arbitrage by reselling to those charged a high price. It also requires the firm to have some market power and to face differing elasticities across groups. Preventing resale is therefore a necessary condition.

Question 47Economics for business: demand, supply, market structures and pricing

What is meant by consumer surplus?

  1. The difference between what consumers are willing to pay and what they actually pay Correct answer.
  2. The revenue earned by sellers above their fixed costs
  3. The total amount consumers spend on a good
  4. The difference between production cost and selling price

Explanation

Consumer surplus measures the benefit buyers receive beyond the price paid, represented by the area below the demand curve and above the market price. It is not the same as total spending, which equals price times quantity. Producer surplus, by contrast, measures benefit to sellers.

Question 48Economics for business: demand, supply, market structures and pricing

A firm's fixed costs are $500 and each unit costs $8 in variable cost to produce. If the market price is $10, what is the break-even quantity?

  1. 250 units Correct answer.
  2. 62.5 units
  3. 500 units
  4. 50 units

Explanation

Contribution per unit is price minus variable cost, here $2. Dividing fixed costs of $500 by the $2 contribution gives 250 units. At that output total revenue equals total cost and profit is zero.

Question 49Economics for business: demand, supply, market structures and pricing

When average cost falls continuously as output expands, the firm is said to be experiencing:

  1. Economies of scale Correct answer.
  2. Diminishing returns
  3. A fixed cost increase
  4. Diseconomies of scale

Explanation

Economies of scale arise when long-run average cost declines as the scale of output increases, often through specialisation, bulk purchasing or spreading fixed costs. Diminishing returns relate to adding variable inputs in the short run. Diseconomies of scale describe rising average cost at larger output.

Question 50Economics for business: demand, supply, market structures and pricing

A firm in monopolistic competition earns supernormal profit in the short run. In the long run, what is expected to happen?

  1. New entrants reduce each firm's demand until normal profit is earned Correct answer.
  2. The firm becomes a monopoly and keeps the profit permanently
  3. Profits rise because entry is blocked by barriers
  4. Price rises above the short-run level as rivals exit

Explanation

Monopolistic competition assumes free entry and exit, so supernormal profit attracts new firms offering similar products. Each incumbent's demand curve shifts left until price equals average cost and only normal profit remains. This long-run zero economic profit result parallels perfect competition.