3.3 Revenue, Costs and Profit

Question 1

Explain Diminishing Marginal Returns

Answer 1

As each additional unit is added, the output increases and the firm reaches full capacity

Question 2

TR, AR, MR formulae

Answer 2

TR= PxQ
AR= P
MR= CTR/CQ

Question 3

Short run condition

Answer 3

At least one FoP needs to be fixed

Question 4

Long run condition

Answer 4

All FoP are variable

Question 5

Law of Diminishing Returns

Answer 5

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

Question 6

Explain Diminishing Average Return

Answer 6

As each worker is adding less and less to output, the average output (productivity) falls

Question 7

What is revenue maximisation point

Answer 7

when MR=0, TR is maximized

Question 8

Economies of scale

Answer 8

A decrease in the LRAC as a result of increased output (Increasing returns to scale)

Question 9

[EOS] Purchasing

Answer 9

As firms increase in scale, they’re often able to negotiate lower prices with their supplier. They have more bargaining power than smaller firms

Question 10

[EOS] Financial economies

Answer 10

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

Question 11

AR, MR, TR and PED

Answer 11

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)

Question 12

Revenue Maximisation and PED

Answer 12

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

Question 13

Why does PED vary along the AR curve

Answer 13

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

Question 14

Define fixed costs and variable costs

Answer 14

FC - costs which do not with output
VC - costs which vary with output

Question 15

SRAC

Answer 15

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

Question 16

Explain why the AFC curve is constantly falling with increased output

Answer 16

TFC remains constant at every level of output. As output increases, the TFC is divided by an increasing quantity. Therefore, it continually decreases.

Question 17

Explain the shape of the MC curve

Answer 17

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)

Question 18

Explain the AVC curve shape

Answer 18

AVC is u-shaped and MC cuts AVC at its lowest point.

Question 19

Explain the Average Cost curve

Answer 19

As output increases, AC falls due to a decrease in AFC
MC cuts AC at its lowest point

Question 20

Define implicit costs

Answer 20

Earnings that the firm could have made if it had employed it’s FoP in their next best profitable use (OC)

Question 21

Define explicit costs

Answer 21

Business’ financial costs

Question 22

Types of Profit

Answer 22

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

Question 23

Profit Maximisation

Answer 23

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

Question 24

TP, AP, MP graph (LODR)

Answer 24

All curves are initially rising, when LODR sets in, MP falls, pulling down TP and MP. When MP=0, TP plateaus

Question 25

Short-run Shut Down point