3.3 - Revenue, costs and profits Flashcards
1
Q
What is marginal revenue?
What is the formula for MR?
A
- The extra revenue that the firm earns from selling one more unit of production
- change in TR/ change in Q
2
Q
What is average revenue?
What is the formula for AR?
A
- Shows how much revenue there is per unit of output
- TR/output
3
Q
What is total revenue?
What is the formula for TR?
A
- The total amount of money coming into the business through sale of goods and services
- no. of units sold x cost per unit
4
Q
What is the relationship between PED and MR?
A
- As price falls, elasticity changes from elastic to unitary elastic (midpoint) to inelastic - as Q falls, demand becomes more elastic
- When MR is positive, PED is elastic
- When MR is negative, PED is inelastic
- When MR is 0, PED = unitary elastic
5
Q
What is marginal cost?
What is the formula for MC?
A
- The extra cost of producing one extra unit of a good
- Change in TC/ Change in Q
6
Q
What is a fixed cost?
Give an example.
A
- Costs that don’t change with output and remain constant
- E.g. rent, machinery, salaries
7
Q
What is a variable cost?
Give an example.
A
- Costs that change directly with output
- E.g. raw materials, electricity bills
8
Q
What is total cost?
What is the formula for TC?
A
- The cost of producing a given level of output
- Fixed + variable costs
9
Q
What is average cost?
What is the formula for AC?
A
- Cost per unit of output
- TC / Q
10
Q
What is a perfectly elastic demand curve and how does this relate to revenue?
A
- These firms are in perfect competition - have no price-setting power, and it’s constant (MR=D=AR=P)
- TR curve is upward sloping - prices are constant -> more goods sold = more revenue
- Firms in imperfect competition have a downward sloping demand curve - price setting power
11
Q
What is diminishing marginal productivity?
A
- 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 decreases as more inputs are added in the SR - marginal COP rises
12
Q
What is diminishing marginal returns? When does it occur?
A
- Increased specialisation occurs as a firm grows in size -> productivity increases -> MC falls
- Additional labour beyond this point -> productivity falls -> fixed resources e.g. kitchen space, ovens
- Decreasing productivity is known as diminishing marginal returns
- Occurs only in the short-run - at least one FOP is fixed
13
Q
Why is AC U-shaped?
A
- Due to the law of diminishing marginal returns (or productivity)
- Costs initially fall as machinery is used more efficiently, but as production continues to expand, efficiency falls as machinery is overused
14
Q
Why is MC U-shaped?
A
- Due to the law of diminishing marginal returns
- It will iniatlly fall as machines are used more efficiently but will rise as production continues to rise
15
Q
Why will the MC curve always cut the AC curve at its lowest point?
A
- If MC is below AC then AC will continue to fall since producing one more costs less than the average so the average falls
- If MC is above AC, then AC will rise
- Marginal costs can be rising while AC is still falling, as long as MC is still below MC
16
Q
What is the relationship between the MC and AVC curve?
A
- When MC is below (MC<AVC) - MC drags AVC down because the cost of producing the next unit is lower than the average
- When MC is above (MC>AVC) - MC pulls AVC up and AVC starts to increase
17
Q
What is the relationship between short-run and long-run cost curves?
A
- SRAC curves are u-shaped due to diminishing marginal returns
- LRAC curves are u-shaped due to economies and diseconomies of scale
18
Q
Describe the LRAC and SRAC curves diagram?
A
- LRAC is an envelope to SRAC as it’s either equal to or below the relevant SRAC
- A firm may initially be set to produce a certain amount a day + have enough machinery to do so effectively
- They could become popular and need to produce more- in the SR SRAC increases due to diminishing marginal returns (fixed resources)
- In the LR (variable factors) SRAC shifts lower -> economies of scale and eventually constant returns to scale then diseconomies
19
Q
What causes a movement along the LRAC and what causes a shift along the LRAC curve?
A
- Movement: due to a change in output - changes average COP due to internal economies/diseconomies of scale
- Shift: due to external economies/diseconomies, taxes, or technology - affects COP for a given level of output
20
Q
What is economies of scale?
A
Occurs when an increase in the scale of output results in a lower cost per unit -> generates efficiencies that lower AC
21
Q
What is diseconomies of scale?
A
Occurs when an increase in the scale of output results in a higher cost per unit
22
Q
What is constant returns to scale?
A
Where firms increase inputs and receive an increase in output by the same percentage
23
Q
What is the minimum efficient scale?
A
- The minimum level of output needed for a business to fully exploit economies of scale
- The point where the LRAC curve first levels off and when constant returns to scale is first met
24
Q
What is an internal economy of scale?
A
Occur as a result of the growth in the scale of production within the firm - when increased output results in lower cost per unit
25
What are the different types of internal economies of scale?
Many Prime Ministers Read Financial Times
- Managerial
- Risk-bearing
- Purchasing
- Marketing
- Financial
- Technological
26
What are managerial economies of scale?
- Large firms can appoint specialist managers in every field - greater knowledge + able to do their job better
- Staff represent an indivisibility - small firms cant employ specialist staff
27
What are purchasing economies of scale?
- When large firms buy raw materials in greater volumes and receive a bulk purchase discount - lowers AC
28
What are marketing economies of scale?
- Larger firms spread the cost of advertising over a large number of sales - reduces AC
- Can also reuse marketing materials in different geographic regions - lowers AC
29
What is risk-bearing economies of scale?
- Occurs when a firm is able to spread the risk of failure by increasing its number of products e.g. greater product diversification - less failure lowers AC
30
What is financial economies of scale?
- Large firms often receive lower interest rates on loans than smaller firms - perceived as less risky -> cheaper loan lowers AC
31
What is technological economies of scale?
- Occurs as a firm can use its machinery at a higher level of capacity due to increased output -> spreads the cost of machinery over more units + invest in specialist capital -> lowers AC
- E.g. Spread Lettuce Farm in Japan - output is 50,000 a day -> run by robots monitoring, sunlight, watering plants etc
32
What is an external economy of scale and what are the different types? Give a real world example.
- Occurs when there is an increase in the size of the industry in which the firm operates - benefits from lower AC generated by factors outside of the firm
Types:
- Knowledge transfers - when an industry expands, knowledge is transferred between firms - helps firms learn effective new production techniques -> LRAC falls - E.g. In LA’s film industry, the green screen technique was spread by knowledge transfer
- Recruitment costs - when an industry expands, lots of specialist workers will move to that area to find work -> easier to recruit workers -> lower recruitment costs -> LRAC falls - E.g. 60,000+ coders in Silicon Valley -> tech firms’ recruitment costs fall
- Transport links
- Geographic cluster
- Skilled labour
- Favourable legislation
33
How do geographic clusters lead to external economies of scale? Give a real world example.
- As an industry grows, ancillary firms move closer to major manufacturers to cut costs & generate more business - lowers AC
- E.g. car manufacturers in Sunderland rely on 2500+ ancillary firms
34
How do transport links lead to external economies of scale? Give a real world example.
- Improved transport links develop around growing industries in order to help get people to work & to improve transport logistics -> lower AC
- E.g. Bangalore (India's Silicon Valley) - transport projects have been successful in transforming the movement of people & goods
35
How does skilled labour lead to external economies of scale?
- An increase in skilled labour can lower the cost of skilled labour -> lowering the AC
- The larger the geographic cluster, the larger the skilled pool of labour
36
How does favourable legislation lead to external economies of scale?
- Often generates significant reductions in AC as governments support certain industries in order to achieve their wider objectives
37
What are the causes of diseconomies of scale?
- Management: where managers work more in their own interest - lowers efficiency
- Communication: when a firm with multiple layers of management or geographic locations can't communicate quickly & efficient
- Geographical: when a firm has widespread bases of operations -> logistical & communication challenges
- Cultural: when a firm expands into foreign markets where workers may have different cultural work norms
38
What are the 3 main reasons for internal diseconomies of scale? Give a real world example.
- Alienation: workers feel isolated from co-workers (cubicles in office spaces) -> productivity falls -> LRAC rises
- Bureaucracy: more managers = more forms needed to track work etc (admin is $21bn of NHS budget) -> LRAC rises
- Communication -> slows down -> productivity falls -> LRAC rises
39
What is the disctinction between normal and supernormal profit?
- Normal profit: breakeven, TR=TC
- Supernormal profit: TR>TC
40
What are short-run shut down points?
- In the SR, if the selling price is higher than AVC, the firm should keep producing (AR>AVC)
- If the selling price (AR) falls to the AVC it should shut down (AR
41
What are long-run shut down points?
- In the LR, ATC=AVC
- LR shutdown - AR=ATC
- If AR>ATC -> profit is made on each unit -> stay in the market
- If the selling price (AR) is equal to or lower than ATC, the firm should shut down (AR
42
When do you shift MC and/or AC?
- Changes in variable costs -> shift MC & AC
- Changes in fixed costs -> shift AC
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