3.3 Revenue Costs and Profits Flashcards
What is revenue
Revenue is the money earned from the sale of goods and services
What is total revenue
● Total revenue (TR): The total amount of money coming into the business through the sale of goods and services. quantity x price
What is average revenue
Average revenue (AR): Demand is equal to AR: total revenue output
What is marginal revenue
Marginal revenue (MR): The extra revenue that the firm earns from selling one more unit of production: total revenue from ‘N’ goods- total revenue from (N-1) goods OR change in total revenue change in output
How does a perfectly elastic demand curve affect revenue
price received by the firm for the good is constant and so MR=AR=D. Their demand curve is horizontal. The TR curve is upward sloping because prices are constant and so the more goods that are sold, the higher the revenue made.
With imperfect competition, how do revenues change
D = AR
MR is 1/2 of Gradient of AR
and TR is dependent on MR elasticity
● If marginal revenue is positive , when the firm sells the product at a lower price (or when they increase output), total revenue still grows and so the demand curve is elastic.
● If MR is negative , TR decreases as price decreases (or output increases) and so the demand curve is inelastic. After output Q, the demand curve is inelastic.
● When MR=0, TR is maximised and the demand curve is unitary elastic
What is seasonal revenues
Seasonality refers to fluctuations in output and sales revenue related to the seasonal of the year.
For most products there will be seasonal peaks and troughs in production and/or sales
What are fixed costs
Business expense that does not vary directly with the level of output
Examples:
* Business insurance
* Consulting fees
Rental fees
What are variable costs
costs that relate directly to the production or sale of a product
Examples:
Energy and fuel costs
Component parts
Packaging costs
What is TC (total cost) and TFC (Total fixed cost) and TVC (Total Variable Cost)
● Total cost (TC): The cost of producing a given level of output: fixed + variable costs
● Total fixed cost (TFC) : Costs that do not change with output and remain constant e.g. rent, machinery
● Total variable cost (TVC): Costs that change directly with output e.g. materials
What is ATC (Average Total Cost), AFC (Average Fixed Costs) and AVC (Average Variable Cost)
● Average (total) cost (ATC): total costs/ output
● Average fixed cost (AFC): total fixed cost/ output
● Average variable cost (AVC): total variable cost /output
What is marginal cost
Marginal cost (MC): The extra cost of producing one extra unit of a good
What is the short and long run
The short run is the length of time when at least one factor of production is fixed and cannot be changed; this varies massively with different types of production. The long run is when all factors of production become variable.
What is diminishing marginal productivity
● Diminishing marginal productivity means that if a variable factor is increased when another factor is fixed
there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit.
● Marginal output will decrease as more inputs are added in the short run. This will mean that the marginal cost of production will rise.
What is the shape of the AFC
● The average fixed cost curve (AFC) starts high because the whole fixed costs are being divided by a small output. As output is increased, AFC falls as the same amount is divided by a larger number.
What is the shape of ATC
● The average total cost curve (AC/ATC) is U-Shaped due to the law of diminishing marginal productivity.
Costs initially fall as machinery is used more efficiently but as production continues to expand, efficiency falls as machinery is overused.
How is the AVC shaped
The average variable cost curve (AVC) is also U-Shaped, but it gets closer to ATC as output increases since AFC gets smaller.
How is MC curve shaped
● The marginal cost (MC) will also be U-Shaped due to the law of diminishing marginal productivity.
It will initially fall as the machines are used more efficiently but will rise as production continues to rise
Where does MC cut AC
The marginal cost line will always cut the AC line at the lowest point on the AC curve
if MC is below AC, then AC will continue to fall since producing one more costs less than the average so the average falls; but if MC is above AC, then AC will rise.
Marginal costs can be rising whilst AC is still falling, as long as MC is still below AC.
Draw MC ATC AVC and AFC with imperfect competition
Why are SRAC and LRAC U shaped
Short run average cost (SRAC) curves because of the **law of diminishing returns **
Log run average cost (LRAC) curves because of **economies and diseconomies of scale. **
How are LRAC and SRAC related
LRAC is the envelope ffor all associated SRAC curves because the LRAC is either equal to or below the relevant SRAC
Draw SRAC’s and LRAC curves and explain the shape
Short run curves get diminishing marginal returns as some factors fixed
Long run curves all factors become variable and so the SRAC curve can be shifted, new SRAC curve will be lower since the firm can have economies of scale
This continues until the firm experiences constant returns to scale and eventually diseconomies of scale
What is the LRAC a boundary for
The long run average cost curve is a boundary representing the minimum level of average costs attainable at any given level of output.
Points below the LRAC are unattainable and producing above the LRAC is inefficient.
What is the LRAC a boundary for
The long run average cost curve is a boundary representing the minimum level of average costs attainable at any given level of output.
Points below the LRAC are unattainable and producing above the LRAC is inefficient.
What causes a movement or a shift along the LRAC curve
**Movement along the LRAC **is due to a change in output which changes the average cost of production due to internal economies/diseconomies of scale.
A shift can occur due to external economies/diseconomies, taxes or technology, which affects the cost of production for a given level of output.
What is the Minimum Efficient Scale
- the minimum level of output needed for a business to fully exploit economies of scale. It is the point where the LRAC curve first levels off and when constant returns to scale is first met.
What are economies of scale
Economies of scale are the advantages of large scale production that enable a large business to produce at a lower average cost than a smaller business
What are diseconomies of scale
the disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise
What are constant returns to scale
firms increase inputs and receive an increase in output by the same percentage
What are internal economies of scale
an advantage that a firm is able to enjoy because of a growth in the firm, independent of anything happening to other firms or the industry in general.
What are the 5 types of internal economies of scale
- Technical Economies
- Financial Economies
- Risk Bearing Economies
- Managerial Economies
- Marketing and purchasing economies
What are technical economies and some examples
- Economies that arise from improvements in the production process
- Specialisation
- Increased dimensiones; if you double the size of a container you increase the amount it can carry by more than double
- Indivisibilty of Capital; spme processes require huge capital
- Research and Development
What are financial economies
● Large firms have greater security because they have more assets so it is easier for them to obtain finance and interest rates will be lower due to lower risk. This makes investment more accessible.
What are risk bearing economies
● Large companies are able to operate in a range of different markets, producing different products which means that if one area of business fails, their whole business will not collapse.
What are managerial economies
● Large companies can afford to appoint specialist managers in every field, who are specialised and so have greater knowledge and are able to do their job better.
Staff represent an indivisibility and so small firms cannot employ specialist staff.
What are marketing and purchasing economies and some types
● Buying in bulk
● Specialisation: Like other areas, businesses can afford to take on specialist buyers and sellers who could be more efficient due to the extra time and knowledge.
●** Distribution**: Large firms are able to enjoy preferential rates from transport companies because they offer the company a lot of businesses.
What are external economies of scale
an advantage which arises from the growth of the industry within which the firm operates, independent to the firm itself. These cause the LRAC curve to shift downwards.
What are the types of external economies of scale
- Labour
- Support Services
- Subsidies
How is labour an external economies of scale
● Businesses established in an area with other successful firms from the same industry find that labour tends to come to that area if they want a job in that industry, for example Silicon Valley. This reduces the cost and time take to recruit.
● Another advantage for large industries is that local education and training providers are more likely to develop courses to prepare people to take up jobs in these businesses.
● Firms will be able to hire staff who have been trained by other businesses , which is cheaper and more efficient for the firm than training the workers themselves.
How is support services an external economy of scale
● Businesses who provide products or services for large businesses will naturally move to the area where those businesses are based, which reduces transport cost/time delays for the business.
What are some types of diseconomies of scale
- Workers
- Geography
- Change
- Price of materials
- Management
How can workers be a diseconomy of scale
- In a large business, people can think their efforts go unnoticed and have less chance of promotion so lose motivation and work less hard.
- They can also lose their sense of belonging and have less personal commitment and identification with the business.
How can geography be a diseconomy of scale
● A firm may have to transport finished products huge distances and firms may find it harder to control parts of the business which is miles away.
How can change be a diseconomy of scale
● It takes much longer and is much more difficult for a large firm to respond to change.
How can the price of materials be a diseconomy of scale
● an increase in demand can cause prices to rise and therefore increase production costs. This could also occur if the whole industry increases and so firms bid up prices.
How can management be a diseconomy of scale
● Coordination and control: As a business grows, it will become progressively more difficult to coordinate and keep control of all the different parts of the business.
● Communication: Within a large business, communication can be slow and also can lose accuracy
What are learning economies of scale
- Industry experience reduces LRAC
○ Workers may become more adapt and Managers schedule the production process more effectively.
What is Agglomeration economies
Businesses in similar industries tend to cluster together and attract an influx of skilled talent which then provides human capital to expanding businesses.
What are economies of scope
Economies of scope happen when it is cheaper to produce a range of products rather than specialize in a limited number……Amazon
How would you evaluate economies of scale
- The nature of production / technology requirements will influence the size of MES relative to market demand
- Economies of scale may run out at a certain point but constant returns to scale means that unit cost will be stable
- Many economies depend on businesses achieving a high rate of capacity utilisation – this lowers the fixed cost per unit
What are the conditions for profit maximisation
- Profit is maximised when TR and TC are furthest apart (TR>TC)
- Also occurs at MC=MR
What happens if MR crosses MC twice
Sometimes, MR and MC may cross at two points and thus the profit maximising point is where marginal cost rises as it crosses the MR line.
What is normal profit and where does it occur
● Normal profit is the return that is sufficient to keep the factors of production committed to the business .
In economics, costs include the level of profit needed to keep the producer in the market and to cover the opportunity cost. Therefore, if the firm covers its costs it earns normal profit.
This is at the point where** AC=AR or TC=TR. **
Where does a loss occur in economics
AR<AC
If a business is making a loss in the short run, when should it shut down
When AVC>AR as producing more goods will increase the loss
If AVC<AR then firms should continue production as each good produces a revenue to help cover the loss
If a business is making a loss in the long run when should it shut down
Firm must make at least normal profits of AC=AR
(also cover fixed costs)
What is the short run shut down price
AVC=AR
(don’t need to cover fixed costs in short run)
Should this firm keep producing in short run, and long run
- AVC cost is only C2 so AR>AVC so can produce in SR
- IN LR needs AC=AR so will have to shut down
What is the evaluation of profit maximisation
- In the real world it is more difficult to maximise profits because firms do not have access to costs and MR data easily; ends up being prediction
- Principle agent problem; profit satisficing
- ESG considerations, other strategies
What is the evaluation of the shutdown price
- The firm may not close down at price of less than shutdown
- if they expect the** fall in demand to be temporary** and they are hopeful they can cut costs. A firm will try to avoid shutting down because it will lose market share and long term customers
What are factors that affect profitability
- Market Share
- Brand Image
- Competition
- Costs
- Exchange rate
- Economic Growth
