3.3 - Revenues, costs and profits Flashcards
Define costs
The expenses incurred in production.
Define total cost
total fixed cost + total variable cost
Define fixed costs
Costs which don’t change with output.
TFC = Fixed costs x price
Define variable costs
Costs which do change with output.
Define average cost/average total cost
The cost of production per unit.
AC = Average fixed costs + average variable cost
ATC = Total cost/quantity
Define average revenue
The price each unit is sold for.
Define constant returns to scale
Output increases by the same proportion that input increases by.
Define decreasing returns to scale
Output is increasing by a smaller proportion than input is increasing by.
Define diminishing marginal productivity/returns
As additional units of a variable factor are added to a given quantity of a fixed factor, the output from each additional unit of the variable factor will eventually diminish. (Less extra output than the previous unit; after a certain point, marginal
output falls).
Define diseconomies of scale
The disadvantages that arise in a large business that cause long run average costs to rise as output rises.
Define economies of scale
The advantages that arise in a large business that cause long run average costs to fall as output rises.
Define external economies of scale
Business-enhancing factors that occur outside a company but within the same industry.
Define increasing returns to scale
Output is increasing more than proportionately than input is increasing by.
Define internal economies to scale
Business-enhancing factors that occur within a businesses’ control and is independent to other firms or the industry in general.
Define loss
When revenue doesn’t cover costs. (TC>TR)
Define marginal cost
The additional cost of producing one extra unit of good.
MC = Change in TC / Change in Q
Define marginal revenue
The additional revenue gained by selling one extra unit of good
MR = Change in TR / Change in Q
Define profit
Total revenue - total costs
Define normal profit
The minimum return needed to keep a firm operating, without exceeding the costs. This occurs when TR = TC.
Define supernormal profit
The amount by which TR > TC
Define explicit costs
Direct payment to others in the course of running a business, such as wage rent and materials.
Define implicit costs
The opportunity costs of the fop used to make a good/service. For example, the time invested in training employees.
Explain the shape of the MC curve (tick shaped)
- Initially the MC curve is downwards sloping as each additional worker costs the same but is adding more to total output than the previous due to specialisation.
- Once the LODMR sets in, workers are producing less than the previous but still being paid the same.
- Afterwards, MC starts to rise.
Explain the shape of the SRAC curve (u shaped)
- Initially the AC curve falls as outif the MC curve is below it.
- Once the LODMR sets in, eventually there will be a level of output where MC rises above AC, causing AC to rise.
Explain the shape of the AFC curve
- AFC constantly falls as output increases.
- This is because TFC will always be fixed in the short run, therefore if you divide it by an increasing quantity, AFC will always be downwards slopping.
Explain the shape of the AVC curve (u shaped)
- MC will cross AVC at its minimum point as if:
MC < AVC then AVC will fall with falling MC (falls as output rises)
MC > AVC then AVC will rise with rising MC
(rises as output rises)
Explain the shape of the TFC curve
TFC is just a horizontal line as fixed costs remain constant.
Explain the shape of the TC curve
- TC is upwards sloping (increases with output as more labour is added), at first at a decreasing rate then at an increasing rate after a certain point.
- Repetition of the TVC curve just shifted up the value of the TFC to reflect its constant nature.
Explain the shape of the TVC curve
-TVC is upwards sloping (increases with output as more labour is added), at first at a decreasing rate.
- Once the LODMR sets in, mc will start to rise which can be seen as an inflexion point on the TVC curve.
- This is because there’s underutilised capital and specialisation gains to be made by adding more workers.
- After this point the gradient gets steeper, causing TVC to increase at an increasing rate.
Explain the shape of the AR curve
- In an imperfect market e.g. monopoly, to sell more firms must lower their price.
- Therefore, the AR curve is the same as the demand curve for a product (AR = D), price is inversely proportionate to the quantity demanded.
- AR is likely to fall as quantity demanded/output rises, this is because each additional unit earns a lower revenue (MR falls) as a result of the lower price charged.
Explain the shape of the MR curve
(in imperfectly competitive market)
- Downwards sloping into the negative axis, this reflects the reduction in revenue resulting from the lower price charged.
- 2x steeper than AR
Explain the shape of the TR curve
(in imperfectly competitive market)
TR rises with output at first but eventually starts to fall. This is because the extra revenue gained from decreasing price and selling more units is outweighed by the loss in revenue from selling units at a cheaper price than before.
Explain RISK BEARING as an internal economy of scale
- Businesses can spread their opportunity cost (risks) over a larger output, by diversification.
- They can sell a wider range of goods or in a wider range of markets. E.G. by selling in different countries.
Explain FINANCIAL as an internal economy of scale
Lower rates of interest as a business gets larger, this is because they’re lower risk when a business is successful therefore they can negotiate lower rates.
Explain MANAGENIAL as an internal economy of scale
- As a firm gets larger they can employ specialist managers.
- This means they can oversee and improve production system, stream-lining processes and increase productivity.
Explain TECHNICAL as an internal economy of scale
Larger businesses able to invest in specialist machinery and efficient factory usage to decrease production costs and increase productivity.
Explain MARKETING as an internal economy of scale
Firms can bulk-buy advertising as the cost of advertising is spread out over a larger number of potential customers.
Explain PURCHASING as an internal economy of scale
- Firms are able to buy raw materials in bulk, as they grow.
- This is because they’re able to negotiate discounts with their bargaining power.
Explain TRANSPORT economies as an internal economy of scale
- Large firms making bulk orders may be charged less for delivery costs than smaller firms.
- Additionally, as firms grow they may have their own transport fleet which will cost less because they won’t be paying other firms who will include a profit margin with it.
What is the revenue maximisation point
TR is maximised when MR = 0 and the PED of AR is 1
What is the effect of an elastic PED on revenue
When the PED of AR is elastic, firms should decrease its prices to increase its revenue.
What is the effect of an inelastic PED on revenue
When the PED of AR is inelastic, firms should increase its prices to increase its revenue.
What is the effect of unitary PED on revenue
When the PED of AR is unitary, firms should keep prices unchanged if they’re wishing to increase revenue as its maximised at this point.
