1.4 Production, Costs and Revenue Flashcards
What is production?
the conversion of factor inputs into final output
facor inputs = land, labour, capital, enterprise
What is total factor productivity?
the output of all factors of production
How to calculate productivity?
total output / total input
What are the 2 types of productivity?
- Labour productivity - output per worker. total output / no. of workers
- Capital productivity - output per unit of capital e.g machinery.
What is productive efficiency?
when no additional output can be produced from factor inputs available
when an economy uses minimum input to produce the maximum output
anywhere on the PPC
What is the average cost curve diagram?
Shows where productive efficieny is.
As output increases cost per unit fall.
Occurs because fixed costs are spread over the higher output.
What are economies of scale?
occur as unit costs fall as the scale of production increases.
How is productive efficiency created through economies of scale?
- Purchasing economies - leads to a reduction in cost
- Specialisation - leads to a more efficient use of inputs
- Better management - lead to increase output with same factor input
What are diseconomies of scale?
occur as unit costs rise as the scale of production increases.
How is productive inefficiency created through diseconomies of scale?
- Lack of communication between employees
- Lack of coordination by management
- Bureaucracy, particularly in larger organisations
What is bureaucracy?
occurs when large organisations, particularly governments, have overly complex administrative procedures
this increases costs
What is purchasing economies?
Refers to bulk buying. Bulk discounts given. Both buyer and seller gain as buyer gets cheaper price and seller sells more in a short period of time
What is specialisation?
occurs when economic units such as individuals, firms, regions or countries concentrate on producing specific g / s.
How does specialisation increase output?
- Greater understanding of the requirments of production
- Can specialise in what they are good at
- efficient use of time as there is no switching tasks
- Technical economies of scale
What is division of labour?
specialised use of workers within an organisation
- leads to increased output per worker
- helps address problem of scarcity as there will be greater supply of g / s.
What is a barter?
occurs when g / s are exchanged for other g / s between two parties. Occurs without a medium of exchange. e.g. money
What is money?
anything that is accepted in exchange for goods and services.
Why is money more efficient than barter?
- Medium of exchange
- Store of value
- Unit of account
- Standard of deffered payment
What is meant by the short-run?
- Atleast one factor of production is fixed
- Looks at Marginal product (return)
- Firms stay in production if covering AVC as this helps them pay off AFC
- Sunk costs = costs that are already paid, not recoverable
What is meant by the long-run?
- All factors of production are variable, therefore, scale of output can be changed
- Looks at returns to scale
- Firms leave industry if they don’t cover ATC
- Prospective costs = costs firms take into account when making investment decisions, are avoidable as they are based on future
What does the Law of Diminishing returns state?
If one factor of production e.g. labour is increased whilst another factor is fixed e.g. capital then productivity of the variable factor will eventually decrease.
Only occurs in the short run, because in the long run all factors are variable.
What is Total (physical) product?
total output produced by a firm given the factor inputs
Average product x Units of variable input
What is Marginal (physical) product?
difference between total output when an extra unit of the variable factor is added
Change in total output / Change in variable input
What is Average (physical) product?
total output produced by a firm divided by the amount of variable inputs
Total output / Units of variable input
Law of Diminishing returns has important implications for a firm
- Inverse relationship between marginal returns and marginal costs
- Once diminshing returns set in each subsequent worker becomes less productive
- This creates the distinctive U-shaped marginal cost curve
Difference of short run and long run production?
- Short run = can add more of the variable factor to the fixed factor of production
- Long run = can add more of the fixed factor, increasing the scale of the firm
- This is an important distinction
How to increase output in short run?
- Economists make assumption that capital is fixed in the short run
- Can only increase output by adding more of the variable factor of production to fixed capital.
How to increase output in long run?
- Firm is able to increase the scale of production leading to economies of scale. i.e. is able to change all factor inputs including capital.
- Economies of scale lead to increased productive efficiency
Returns to scale: categorised in 3 ways
- Increasing returns to scale
- Constant returns to scale
- Decreasing returns to scale
What is Increasing returns to scale?
Occurs if output increases by proportionally more than the input
input increases by 10% and output increases by 15%
What is Constant returns to scale?
Occur if output increases by the same amount as input
input increases by 10% and output increases by 10%
What is Decreasing returns to scale?
Occurs if ouput increases by proportionately less than input
input increases by 10% and output increases by 5%
What does Returns to scale look at?
changes in the level of output due to a change in factor inputs
What does Economies of scale look at?
changes in the average cost per unit of output as a firm increases the scale of production
What are fixed costs (FC) or total fixed costs (TFC)?
- They do not vary with ouput
- Rent, capital e.g. machineries
- FC curve shown as a horizontal line
Average fixed costs (AFC) = total fixed cost / output
What are variable costs (VC)?
- Vary with output
- As output increases so does VC and vice versa
- Raw materials
- VC curve slopes upwards, to the right
What are total costs (TC)?
total fixed cost (TFC) + total variable costs (TVC)
TC curve slopes upwards and to the right
What are marginal costs (MC)?
- Cost of producing an additional unit of output
- MC curve is U-shaped
What is average cost (AC) or total average cost (ATC)?
- Average cost of producing a unit of output
- AC curve is U-shaped
total cost / output
What are short run costs (SR)?
- Occur where at least some costs are fixed
What are long run costs (LR)?
- Occur where all costs can be variable
Short run and Long run AC curves
- Each SRAC curve shows the Law of Diminishing returns
- The LRAC curve shows what happens as the firm increases the scale of production
- Each SRAC curve is below the previous one due to economies of scale not diminishing returns
for more info see 1.4.4, second page
What is Long run total cost (LRTC)?
- Unlike short-run total cost, LRTC cannot be separated into FC and VC.
- In the long run all inputs are variable, so all costs is also variable
- LRTC is the TC incurred by a firm in production when all inputs are available
What are short run cost curves?
- Looks at the impact of productivity on a firm. At first, average cost per unit increases as we add more unit of labour
- Increasing labour increases the productivity leading to lower average costs per unit
- At some point diminishing returns set in and the additional unit of labour increases average cost per unit
What are long run costs curves?
- Looks at impact of factor prices on a firm. As firm increases scale of production, economies of scale lead to lower average costs per unit
- At some point diseconomies of scale start to outweigh economies of scale and the average cost per unit begins to rise
What is optimal resource mix?
- How we refer to the best way of combining the factors of production in order to meet these requirements within financial constraints
What is capital intensive production?
uses high proportion of capital such as machinery in the production of a g/s
occurs in secondary sector of the economy i.e. manufacturing
What is labour intensive production?
uses high proportion of workers in the production of a g/s
occurs in the tertiary sector of the economy i.e. services
What are Economies of scale?
Occur when there is a fall in the average total cost as the scale of production increases
What are Internal economies of scale?
Occur when a firm or a plant within the firm itself, increases its scale and size
What are External economies of scale?
Occur when average or unit costs of production fall because of growth in the industry or market in which the firm operates
What are Technical economies of scale?
are generated through changes to the ‘productive process’
economies of scale achieved via technology
What are the different internal economies of scale?
1/2
- Indivisibilities - machinery has a minimum size it can operate
- Spread R+D costs - spread over long production run, reducuing cost in LR
- Volume economies - cost increases less than capacity
- Economies of massed resources - identical machinery = fewer spare parts needed
- Economies of vertically linked processes - linking processes in a single plant = saved cost, time, energy
What are the different internal economies of scale?
2/2
- Managerial - specialise managers
- Bulk-buying - purchase lots of supplies at low price
- Marketing - spread over large output - lower advertising cost per unit
- Finance raising - large firms can ‘bulk-borrow’ at a lower interest rate than small firms
- Risk-bearing - spread risk by diversifying output
- Economies of scope - shared HR, marketing, etc.
What are the internal diseconomies of scale?
- Managerial - firm grows administration becomes difficult, delegation
- Communication - too many layers of management, workers unappreciated, productivity can fall
- Motivational - large firms struggle to motivate workers, over specialisation can lead to de-skilling - workers perform boring tasks
Why does External economies of scale occur?
A result of the growth of the market or industry.
Often because lots of firms operate geographically close
Can also occur as infrastructure improves
How do diseconomies of scale occur?
Firms being located closely leads to competition for factors of production along with congestion
What is the Minimum efficient scale (MES)?
When the LRAC curve is at its lowest point than can be achieved
- If the MES occurs at low levels of output in relationship to the size of the market, their is likely to be a large number of firms
- As MES increases there will be fewer firms in the market
- Creates barrier to enty for new firms wishing to enter the market, because small firms don’t have the finances to increase scale of production
1.4.5
3rd and 4th page
Revise on paper because of graphs
- MES
- Relationship between returns to scale and economies or diseconomies of scale
- Perfect competition
- Monopolistic competition
- Oligopoly/monopoly
What is Total revenue (TR)?
money received by a firm from the sale of goods and services
TR = Quantity x Price
What is Average revenue (AR)?
total revenue divided by output
AR = TR / Quantity
Link between Average revenue curve and Demand curve?
- Demand curve shows quantity demanded for a good, at any price in a given time period
- Therefore average revenue curve is same as demand curve
What is Marginal revenue (MR)?
the increase in revenue from an additional unit of output
MR = Change in TR / Change in Q
What is Profit?
Difference between total revenue and total cost
What is Normal profit?
Minimum profit a firm must make to stay in business
insufficient to attract new firms into market
What is Supernormal profit?
Level of profit over and above normal profit
Occurs where AR>AC
Attracts new firms into market
Role of profit in a market?
Worker incentives - profit-related pay can increase worker motivation
Shareholder incentives - high profit = high dividends, lead to high incentive to buy firms shares
What is Resource allocation?
HIgh profits in a market can lead to more entrants
However, loss making firms will be incentivised to leave.
Reward for innovation/risk taking?
if entrepreneurs believe profit can be made through innovation, it will encourage further innovation in the future.
How do objectives of firms impact profit?
Profit maximising firms will aim to make supernormal profits in imperfectly competitive markets
Sales maximisation will mean that the firm might still make supernormal profits but not at the maximum level
Profit satisfices firm will make supernormal profit but not at the maximum level.
What is Technological change?
describes the process of innovation, invention and the widespread use of technology in society
What is Technological progress?
occurs when technological change increases output for the same given factor inputs
What is mechanised and automated?
Mechanised - humans operate machines
Automated - machines operate other machines
What is Dynamic efficiency?
improvements in productive efficiency that occur in the long-run over time
How does Technological change affect market structure?
Increases no. of firms in industry:
- reduces barrier to entry
- greater scope for competition
- reduces monopoly power
Investment in new technology is expensive. What does this lead to?
High fixed costs:
- requirment to produce significant output
- require increased scale of producion
- creates barrier to entry, and tendency towards oligopolistic markets
What is ‘creative destruction’?
when innovation leads to the development of new poroducts and processes that displace firms that currently dominate industries
