1.4 Production, costs, and revenue Flashcards
Production
converting inputs into outputs of goods and services
Factors of production (4)
Inputs into the productive process; land, labour, capital enterprise
Total cost
the whole cost of producing a particular level of output
Total Cost Formula
fixed costs + variable costs
Fixed costs
cost of production which, in the short run, does not change with output
Variable cost
cost of production which, in the short run, changes with the amount that is produced
Marginal
a prefix used in economics to indicate a point of possible change
Marginal cost (MC)
the change in total costs associated with a one-unit change in output
Average
a prefix used in economics to indicate a figure has been divided by quantity of output
Average cost (AC)
the total cost divided by the quantity produced
Total product
the quantity of output measured in physical units produced by a given number of inputs over a period of time
Long run production
all factors of production are variable
Short run production
at least one factor of production is fixed; more can be produced but the firm will come up against the law of diminishing returns if it tries to do so
Division of labour
different workers perform different tasks in the course of producing a good or a service
Assembly line
production organised into a series of processes by which a succession of identical goods become progressively assembled
Price competition
when a firm reduces prices in order to sell more goods
Productivity
output per unit of factor of production
Labour productivity
Output per unit of labour
Capital productivity
Output per unit of capital
Law of diminishing returns
where increasing amounts of a variable factor are added to a fixed factor and the amount added to total product by each unit (ie the marginal and average product) of the variable factor eventually decreases
Advantages of division of labour (4)
- Increases productivity of workers
- Cheaper unit costs
- Lower training cost
- lower costs of production give firm a competitive advantage in price competition
What do changes in marginal product suggest about average cost?
- as marginal product rises, average product is rising and average cost is falling
- as marginal product falls, average product is falling and average cost is rising
Functions of money (4)
- medium of exchange
- measure of value
- store of value
- standard of deferred payment
Specialisation
workers, firms, regions or nations performing a narrow range of tasks or producing a certain range of goods, and trading the surplus with others
Absolute advantage
where a country can produce more of a good than other countries with the same amount of resources
Double coincidence of wants
two people who want to exchange goods of equal value
Trade
the buying and selling of goods and services
Exchange
to give something in return for something received. Money is a medium of exchange
money
an asset that can be used as a medium of exchange; it is used to buy things
Internal economies of scale
long-run average costs falling caused by growth of the firm [due to increasing returns to scale)
Internal diseconomies of scale
long-run average costs rising caused by growth of the firm [due to decreasing returns to scale)
External economies of scale
long-run average costs falling caused by growth of the industry or market of which the firm is a part
External diseconomies of scale
long-run average costs rising caused by growth of the industry or market of which the firm is a part
Productively Efficient Output
output with the lowest average cost of production; occurs where MC = AC
Types of internal economies of scale (6)
- risk-bearing
- financial
- managerial
- technological
- marketing
- purchasing
Risk-bearing economies of scale
- When a firm becomes larger, they can expand their production range.
- Therefore, they can spread the cost of uncertainty.
- If one part is not successful, they have other parts to fall back on.
Financial economies of scale
Banks are willing to lend loans more cheaply to larger firms, because they are deemed less risky. Therefore, larger firms can take advantage of cheaper credit.
Managerial economies of scale
- Larger firms are more able to specialise and divide their labour.
- They can employ specialist managers and supervisors, which lowers average costs.
Technological economies of scale
Larger firms can afford to invest in more advanced and productive machinery and capital, which will lower their average costs
Marketing economies of scale
Larger firms can divide their marketing budgets across larger outputs, so the average cost of advertising per unit is less than that of a smaller firm
Purchasing economies of scale
- Larger firms can bulk-buy, which means each unit will cost them less. For example, supermarkets have more buying power from farmers than corner shops, so they can negotiate better deals
Types of internal diseconomies of scale (3)
- control
- co-ordination
- communication
Control diseconomies of scale
It becomes harder to monitor how productive the workforce is, as the firm becomes larger.
Coordination diseconomies of scale
It is harder and complicated to coordinate every worker, when there are thousands of employees.
Communication diseconomies of scale
Workers may start to feel alienated and excluded as the firm grows. This could lead to falls in productivity and increases in average costs, as they lose their motivation.
Examples of external economies of scale (6)
- Skilled labour force
- improved infrastructure
- Access to suppliers
- Similar businesses in the area
- good reputation
- specialised services and markets
Total revenue
all the money received by a firm from selling its total output
Total revenue =
Price x Quantity
Average revenue (AR) =
total revenue/quantity
Marginal revenue (MR) =
change in total revenue / change in quantity
Revenue maximisation occurs at
MR=0
Describe the relationship between the MR curve and the AR curve
The MR curve falls twice as quickly as the AR curve
Profit-maximising level of output occurs at
MR = MC
Sales maximisation occurs at
AC = AR
Profit
the difference between total revenue and total cost
Total profit =
total revenue - total cost
Normal profit
the minimum profit required to keep factors of production in their current use in the long run, however insufficient to attract new firms to the market
Abnormal/supernormal profit
The profit over an above normal profit
Subnormal profit
profit below normal profit
Shutdown point
the minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run
Chain of production
the route that a good takes (through primary, secondary, and tertiary sectors) from being a raw material to being a good
Value added
the amount by which the value of goods is increased at each stage of production
Value added tax (VAT)
an expenditure tax on goods charges at each stage of production as a percentage of the value added at that stage
Marginal returns of labour
the change in the quantity of total output resulting from the employment of one more worker, holding all the other factors of production fixed
Average returns of labour
total output divided by the total number of workers employed
Total returns of labour
total output produced by all workers employed by a firm
Plant
an establishment, such as a factory, a workshop, or a retail outlet, which is owned and operated by a firm
Long-run
the time period in which no factors of production are fixed and in which all the factors of production can be varied
Returns to scale
the rate by which out put changes if the scale of all the factors of production is changed
Increasing returns to scale
increasing the scale of all factors of production causes a more than proportionate increase in output
Constant returns to scale
increasing the scale of all factors causes a proportionate increase in output
Decreasing returns to scale
increasing the scale of all factors of production causes a less than proportionate increase in output
Minimum efficient scale (MES)
the lowest output at which the firm is able to produce at the minimum achievable LRAC
Market structure
the characteristics of a market which determine the behaviour of firms within the market (e.g. no. of sellers, no. of buyers, ease of entry for new firms)
Barriers to entry
makes is difficult or impossible for new firms to enter the market
Natural monopoly
where there is only room in a market for one firm benefitting from economies of scale to the full
Examples of natural monopolies
railways, water network, electricity grid, broadband network
why are these examples of natural monopolies?
- all have high infrastructural costs
- a market structure with one firm would therefore have lower LRAC than a structure with more than one
Describe the LRAC curve of a natural monopoly
- falls continuously over a large range of output
- result may be that there is only room in a market for one firm to fully exploit the economies of scale that are available and therefore achieve productive efficiency
Describe the LRAC curve for perfect competition
- horizontal line
- firms neither benefit from economies of scale nor suffer diseconomies of scale
- no firm is at a cost advantage or disadvantage to other firms
Describe the LRAC curve for monopolistic competition
- diseconomies of scale at low levels of output
- MES is small share of total market demand
- many small firms in market
Describe the LRAC curve for oligopoly
- economies of large scale production
- diseconomies of scale eventually set in but only after substantial economies have been achieved
- MES at high level of output
- room for more than one firm as diseconomies do eventually come into effect
invention
making something entirely new; something that did not exist before
Innovation
improves on or makes significant contribution to something that has already been invented, thereby turning the results of invention into a product
Capital intensive production
production that makes more use of capital relative to labour
Labour intensive production
production that makes more use of labour relative to capital
Mechanisation
process of moving from a labour-intensive to a more capital-intensive method of production, employing more machines and fewer workers
Automation
the use of capital equipment with automatic control where machines operate other machines and so are capable of completely replacing labour in the production process
moving assembly line
an assembly line where completed and semi-completed goods are mechanically moved between the assembly processes, forcing labour to work at the speed that the goods are moving
dynamic efficency
occurs in the long run, leading to the development of new products and more efficient processes that improve productive efficiency
Creative destruction
a process where firms produce or create innovative new products that replace or destroy existing products in the market
the law of one price
in the absence or trade frictions (such as transport costs and tariffs) and under conditions of free competition and price flexibility (where no individual sellers or buyers have the power to manipulate prices and prices can freely adjust), identical goods sold in different locations must sell for the same price when prices are expressed in common currency
Why might improvements in technology cause demand for labour to increase?
- makes labour more productive (output per worker increases) so demand increases
- demand for a certain type of labour may decrease, causing demand for another type to increase
Why might improvements in technology cause demand for labour to decrease?
- increases capital productivity and may cause firms to want to adopt automated production processes, causing demand for labour to fall
- demand for a certain type of labour may increase, causing the demand for another to decrease
How does an improvement in dynamic efficiency affect the LRAC curve?
downward shift
How has the invention of e-commerce affected firms? (4)
- firms can now exist without physical premises
- reduced barriers to entry as it is easier to enter the market without having to set up a physical outlet/branch
- number of firms increase
- larger range of products for consumers to choose from, with the ability to compare prices easily
primary sector
extractive and agricultural industries (e.g. farming, logging, hunting, fishing, and mining)
Secondary sector
industries involved in producing consumer goods and capital goods
Tertiary sector
industries involved in the production of services (e.g. retailing)
uncertainty
the degree to which information is imperfect or unknown
waste
the consumption of resources without value being added
scientific management
the use of scientific methods to determine the more efficient production processes in order to increase productivity
