3.3 Revenue, costs and profits Flashcards
What is total revenue?
Price x Quantity
What is average revenue?
Total Revenue
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Quantity
What is marginal revenue?
The revenue gained with each additional unit sold - i.e. the change in total revenue from selling more than one unit
How does elasticity affect revenue?
If a firm lowers prices on the elastic part of the AR curve, then total revenue will increase
However, if it lowers prices on the inelastic part of the AR curve, then total revenue will decrease
What do the AR and MR curves look like?
The MR is twice as steep as the AR.
What is the short-run (in terms of costs)?
A time where at least one factor of production is fixed, e.g. rent
What is the long run (in terms of costs)?
A time period where all factors of production are variable
What are fixed costs?
These are short-run costs that do not vary with output
What are variable costs?
Costs that do vary with output, such as raw material consumption
What are total costs?
This is Total Fixed Costs (TFC) + Total Variable Costs (TVC)
What is average fixed cost?
total fixed costs
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output
What is average variable cost?
total variable costs
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output
What is average cost?
average costs per unit of output =
ATC or (AFC+AVC)
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output
What is marginal cost?
The change in total costs when one more unit of output is produced
What does the short-run average cost curve look like?
Why?
As you approach Q1, there are increasing returns to a fixed factor - as greater inputs are added to a fixed factor (such as a shop), output is increasing at a faster and faster way, hence average costs are falling
However, from Q1, the firm will experience diminishing returns to a fixed factor - as greater inputs are added, they start to add less than the last to total output, which means that average costs begin to rise (for example, from overcrowding of staff)
This can also be called diminishing marginal productivity - after Q1, the addition of each input produces less output as productivity is hampered
What does the marginal cost curve look like? (with AC)
Why?
Initially, marginal costs starts to decrease as the cost of the second good does not include the fixed costs, and you experience increased marginal productivity.
However, marginal costs then increase because of diminishing marginal productivity
As soon as MC intersects AC, AC begins to increase - this is because the cost of producing another good (marginal) is now greater than the average, and so the average cost begins to rise
What does the long-run average cost curve look like?
Why?
As a firm increases its scale, economies of scale allow it to move onto lower SRAC curves.
Joining all of the SRAC curves together produces the long run average cost curve (LRAC).
The point where the LRAC is lowest is called the minimum efficient scale (Q3)
After the MES, the firm experiences disceonomies of scale, which creates higher average costs at higher outputs
What are economies of scale?
A fall in long-run average costs as output increases
There are two types:
- Internal - a fall in costs for an individual firm as its output increases
- External - when an individual firm expands, the industry benefits and their average costs fall too
Give 4 examples of internal economies of scale
- Purchasing economies - as a firm gets larger, it can afford to purchase its raw materials more cheaply through bulk buying
- Financial economies - the rate of interest charged to large firms may be lower than that of small firms because small firms are often deemed to be riskier ventures.
- Risk-bearing economies - the ability of large firms to spread the costs of uncertainty of production over a large level of output and thereby reduce unit cost.
- Technical Economies - when a firm increases physical capacity and costs rise less than proportionately. For example, studies have shown that when oil firms increase the size of their tankers from 30,000 tons to 90,000 tons, costs do not rise threefold so cost per unit fall.
Give 2 examples of external economies of scale
- Retailers located close to each other are able to benefit from the development of new roads and transport links
- A group of small businesses is able to share administrative and secretarial facilities and therefore lower long-run costs per unit
What is profit?
Profit is the difference between revenue and costs
What are the two types of profit?
- Accounting profit: revenue - costs
- Economic profit: revenue - economic cost
Economic cost is cost including opportunity cost of producing elsewhere
Where is profit maximised?
Where marginal cost = marginal revenue
Why is profit maximised at MC = MR?
This is where the difference between total cost and total revenue is greatest, hence profit is greatest
What are the three types of profit?
- Supernormal profit: AR > AC
- Normal profit: AR = AC
- Subnormal Profit (economic loss): AC > AR
Should a firm shut down immediately if it is making an economic loss? Why/why not?
It depends on whether revenue is larger than the average variable cost:
If it is lower - the firm should shut down immediately.
If it is higher* - the firm should *continue to run in the short-run so it can use its revenue to contribute towards fixed costs. This is because the loss made from shutting down immediately is greater than the loss made by operating in the short-run.
Should this firm shut down immediately, or in the long-run?
Immedietely - AR is less than AVC as well as AC , meaning that neither variable costs or fixed costs are being covered and so the firm should shut down straight away
