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 entire cost of producing at a particular level of output
Total Cost Formula
fixed costs + variable costs
Fixed costs
fixed costs are costs that do not change with the level of output produced by a firm.
Variable cost
cost of production which changes with the amount that is produced
Marginal cost (MC)
the change in total costs from change in one unit of output
Average cost (AC)
the total cost divided by the quantity produced
Total product
the total amount of output produced by a firm with a given amount of inputs (like labor, capital, and land) in a specific period of time.
Long run production
all factors of production are variable
Short run production
In short-run (SR) production, at least one factor of production (usually capital, such as machinery or factory space) is fixed, while others can be varied.
output can only be increased by adding more variable inputs (e.g., hiring more workers) but not by expanding fixed inputs.
A key concept in SR production is diminishing marginal returns as more variable inputs (e.g., workers) are added to a fixed input (e.g., a factory), each additional worker contributes less to output than the previous one. This happens because overcrowding or limited resources reduce efficiency. As a result, marginal product (MP) initially rises but eventually falls, leading to rising marginal costs (MC) in the short run. Firms aim to produce where marginal cost equals marginal revenue (MC = MR) to maximise profit, even if they cannot adjust all inputs immediately.
Division of labour
The division of labour refers to the process of breaking down a production task into smaller, specialised tasks performed by different workers. This increases efficiency and productivity, as workers focus on specific roles where they can develop expertise.
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)
Specialisation – Workers become skilled at a narrow task, improving speed and quality.
Increased Productivity – Repetition reduces time wasted switching tasks (e.g., assembly lines).
Lower Costs – Higher output per worker reduces average production costs.
Time-Saving – No need for workers to learn multiple skills, speeding up production.
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
Specialisation occurs when individuals, firms, regions, or countries focus on producing a limited range of goods or services where they have a comparative advantage (the ability to produce at a lower opportunity cost than others). This increases efficiency
Absolute advantage
where a country can produce more of a good than other countries with the same amount of resources
Trade
the buying and selling of goods and services
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 such as advertisement across larger outputs, so the average cost of advertising per unit is less than that of a smaller firm
Advertising Costs
Small Business: Spends £1,000 on ads to sell 100 units.
→ Advertising cost per unit = £10.
Amazon: Spends £100 million on ads but sells 1 billion units.
→ Advertising cost per unit = £0.10.
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 (3)
Skilled Labour Pool – More trained workers available (e.g., tech firms in Silicon Valley).
Infrastructure Improvements – Better transport/networks due to industry demand.
Supplier Clusters – More local suppliers reduce costs (e.g., car manufacturers near steel plants).
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 shut down price is the minimum price a business needs to justify remaining in the market in the short run
A business needs to make at least normal profit in the long run to justify remaining in an industry but in the short run a firm will continue to produce as long as total revenue covers total variable costs or price per unit > or equal to average variable cost (AR = AVC). This is called the short-run shutdown price.
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 tax (VAT)
an indirect tax imposed on the value added at each stage of production and distribution of goods and services. It is ultimately paid by the final consumer but collected and remitted to the government by businesses.
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
Long-run
the time period in which no factors of production are fixed and in which all the factors of production can be varied
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
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 fullest
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
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
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
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
the part of the economy that involves the provision of services rather than the production of goods.
disadvantages to division of labour(3)
Monotony & Worker Dissatisfaction – Repetitive work can reduce motivation.
Over-Reliance on Specific Workers – Absences or strikes can disrupt production.
Structural Unemployment Risk – If a task becomes automated, specialised workers may struggle to adapt.
economies of scale
Economies of scale occur when a firm’s average costs of production (AC) fall as its output increases. This happens because larger firms can spread costs over more units, operate more efficiently, and negotiate better deals.
