3.3 Revenue, Costs and Profit Flashcards
Explain Diminishing Marginal Returns
As each additional unit is added, the output increases and the firm reaches full capacity
TR, AR, MR formulae
TR= PxQ
AR= P
MR= CTR/CQ
Short run condition
At least one FoP needs to be fixed
Long run condition
All FoP are variable
Law of Diminishing Returns
If successive units of a variable input are added to a fixed input, then these extra input will rise at first but will soon decline
Explain Diminishing Average Return
As each worker is adding less and less to output, the average output (productivity) falls
What is revenue maximisation point
when MR=0, TR is maximized
Economies of scale
A decrease in the LRAC as a result of increased output (Increasing returns to scale)
[EOS] Purchasing
As firms increase in scale, they’re often able to negotiate lower prices with their supplier. They have more bargaining power than smaller firms
[EOS] Financial economies
Larger firms can raise capital more cheaply than small firms. Banks are more willing to charge lower interest rates as they’re considered to be less of a risk when borrowing
AR, MR, TR and PED
When MR=0 PED is 1
the first half of the graph is elastic (PED above 1)
the second half or the graph is inelastic (PED below 1)
Revenue Maximisation and PED
When PED is elastic (>1) firms wanting to ^rev should decrease Price
When PED is inelastic (<1) firms wishing to ^rev should ^P
When PED is unitary (1) shouldn’t change P
Why does PED vary along the AR curve
Proportion of income. Demand is elastic and takes up a large proportion of income. Beyond a certain point, the good takes up a lower proportion and D^ more than prop. TR falls
Define fixed costs and variable costs
FC - costs which do not with output
VC - costs which vary with output
SRAC
u-shape, if MC is below SRAC then it will be falling [SRAC is being dragged down, when marginal returns sets in, there will be an output level where MC rises above SRAC]
If MC is above SRAC then it will be rising
Explain why the AFC curve is constantly falling with increased output
TFC remains constant at every level of output. As output increases, the TFC is divided by an increasing quantity. Therefore, it continually decreases.
Explain the shape of the MC curve
Initially it is downwards sloping, because each additional worker costs the same but they are adding more to total output than the previous worker (due to specialization)
Explain the AVC curve shape
AVC is u-shaped and MC cuts AVC at its lowest point.
Explain the Average Cost curve
As output increases, AC falls due to a decrease in AFC
MC cuts AC at its lowest point
Define implicit costs
Earnings that the firm could have made if it had employed it’s FoP in their next best profitable use (OC)
Define explicit costs
Business’ financial costs
Types of Profit
Supernormal - amount by TR>TC
Normal - TR=TC minimum to keep the firm operating (explicit+implicit but no extra)
Break even point - level of OUTPUT where TR=TC
Loss-making - TR<TC whereby TR is less than all economic costs
Profit Maximisation
when MC=MR
if they expand further than MC=MR, they will make a loss as MC>MR.
if they reduce Q, they will be missing out profit from those units as MR>MC
TP, AP, MP graph (LODR)
All curves are initially rising, when LODR sets in, MP falls, pulling down TP and MP. When MP=0, TP plateaus
Short-run Shut Down point
