3.3 Revenues, Costs and Profits

Question 1

Total Revenue (TR)

Answer 1

Total amount of money coming into the business through the sale of goods/services
Quantity x Price

Question 2

Average Revenue (AR)

Answer 2

Demand is equal to AR
Total revenue / Output

Question 3

Marginal Revenue (MR)

Answer 3

The extra revenue the firm earns from selling one more unit of production
Change in total revenue / Change in output

Question 4

Relationship between PED and TR

Answer 4

Pricing decisions to increase TR:
Elastic Opposite
- To increase TR when demand is elastic, decrease price
Inelastic Opposite
- To increase TR when demand is inelastic, increase price

Question 5

Total Cost (TC)

Answer 5

The cost of producing a given level of output
Fixed + Variable costs

Question 6

Total Fixed Cost (TFC)

Answer 6

Costs that do not change with output and remain constant e.g. rent, machinery

Question 7

Total Variable Cost (TVC)

Answer 7

Costs that change directly with output e.g. materials

Question 8

Average Total Cost (ATC)

Answer 8

Total costs / Output

Question 9

Average Fixed Cost (AFC)

Answer 9

Total fixed cost / Output

Question 10

Average Variable Cost (AVC)

Answer 10

Total variable cost / Output

Question 11

Marginal Cost (MC)

Answer 11

The extra cost of producing one extra unit of a good
Change in total cost / Change in output

Question 12

Law of Diminishing Marginal Returns (effects businesses in the short run)

Answer 12

In the short-run when variable factors of production are added to a stock of fixed factors of production, total/marginal product will initially rise, then fall
i.e. At some point in the production process, adding more inputs leads to a fall in marginal output
- Labour Productivity increasing
i)Specialisation ii)Utilisation of fixed factors of production
- Labour Productivity decreasing
i)Fixed factors of production constrain production e.g. lack of space (land) for employees (labour)

Question 13

Short-run

Answer 13

When there is at least one fixed factor of production
i.e. capital and land
Therefore only way to increase output it by increasing labour (“variable factor of production”)

Question 14

Relationship between short-run and long- run average cost curves

Answer 14

The LRAC curve holds the SRAC curve, and it is always equal to/below the SRAC.
- LRAC curve shifts when there are external economies of scale, i.e. when an
industry grows.
- SRAC falls at first, and then rises, due to diminishing returns.
- In the long run, costs change due to economies and diseconomies of scale.

Question 15

What happens if SRAC=LRAC

Answer 15

The firm operates where it can vary all factor inputs

Question 16

Internal economies of scale occurrence

Answer 16

These occur when a firm becomes larger, AC of production fall as output increases

Question 17

Economies of scale examples

Answer 17

(Really Fun Mum’s Try Making Pies): Risk-bearing, Financial, Managerial, Technological, Marketing, Purchasing

Question 18

Risk-bearing

Answer 18

When a firm becomes larger, they can expand their production range.
Therefore, they can spread the cost of uncertainty. If one part is not successful, they
have other parts to fall back on.

Question 19

Financial

Answer 19

Banks are willing to lend loans more cheaply to larger firms, because they are deemed less risky. Therefore, larger firms can take advantage of cheaper credit.

Question 20

Managerial

Answer 20

Larger firms are more able to specialise and divide their labour. They
can employ specialist managers and supervisors, which lowers average costs.

Question 21

Technological

Answer 21

Larger firms can afford to invest in more advanced and productive machinery and capital, which will lower their average costs.

Question 22

Marketing

Answer 22

Larger firms can divide their marketing budgets across larger outputs, so
the average cost of advertising per unit is less than that of a smaller firm.

Question 23

Purchasing/Pricing

Answer 23

Larger firms can bulk-buy, which means each unit will cost them less. For example, supermarkets have more buying power from farmers than corner shops, so
they can negotiate better deals.

Question 24

Network economies of scale *

Answer 24

These are gained from the expansion of ecommerce e.g. large online shops such as ebay can add extra goods and customers at a very low cost, but the revenue gained will be significantly larger

Question 25

External economies of scale occurrence

Answer 25

These occur within an industry when it gets larger. For example, local roads might be improved, so transport costs for the local
industries will fall.
Also, there might be more training facilities or more research and development,
which will also lower average costs for firms in the local area.

Question 26

Diseconomies of scale occurrence

Answer 26

These occur when output passes a certain point and average costs start to increase per extra unit of output produced (gets harder to run a larger/growing firm) (downsides of economies of scale/running a larger firm)

Question 27

Diseconomies of scale examples

Answer 27

(CCC): Control, Coordination, Communication

Question 28

Control

Answer 28

It becomes harder to monitor how productive the workforce is, as the firm becomes larger.

Question 29

Coordination

Answer 29

It is harder and complicated to coordinate every worker, when there
are thousands of employees.

Question 30

Communication

Answer 30

Workers may start to feel alienated and excluded as the firm
grows. This could lead to falls in productivity and increases in average costs, as they lose their motivation.

Question 31

LRAC and economies of scale

Answer 31

Initially, average costs fall, since firms can take advantage of economies of scale so AC are falling as output increases
After the optimum level of output, where AC are at their lowest, average
costs rise due to diseconomies of scale.
- The point of lowest LRAC is the minimum efficient scale. This is where the optimum
level of output is since costs are lowest, and the economies of scale of production have been fully utilised.

Question 32

Minimum efficient scale

Answer 32

The lowest point on the LRAC, where the optimum level of output is since costs are lowest, and the economies of scale of production have been fully utilised.

Question 33

Profit

Answer 33

Profit is the difference between total revenue and total cost. It is the reward that
entrepreneurs yield when they take risks.

Question 34

Profit maximising condition

Answer 34

This occurs when marginal cost = marginal revenue (MC = MR). This is so that each extra unit produced gives no extra loss or no extra revenue.

Question 35

Normal profit

Answer 35

The minimum reward required to keep entrepreneurs supplying their enterprise in the long run. It covers the opportunity cost of investing funds into the firm (not elsewhere). This is when total revenue = total costs (TR = TC).
- Normal profit is considered to be a cost, so it is included in the costs of production

Question 36

Supernormal profit

Answer 36

The profit above normal profit. This exceeds the value of opportunity cost of investing funds into the firm. This is when TR > TC.
- AKA abnormal or economic profit

Question 37

Losses

Answer 37

A firm makes a loss when they fail to cover their total costs

Question 38

Shutting down and AC relationship

Answer 38

When shutting down, no variable costs are incurred by the firm. However, fixed costs
have to be paid whether the firm shuts down or continues to produce, meaning fixed costs are not considered when a decision to shut down is being made.
- The shut-down point is P < AVC, when variable costs cannot be covered. This is at the
lowest point on the AVC curve.

Question 39

Shutdown point

Answer 39

The shut-down point is P < AVC, when variable costs cannot be covered. This is at the
lowest point on the AVC curve.

Question 40

Short-run and Long-run shutdown

Answer 40

When a firm shuts down, it is a short run decision. This means production is only
temporarily stopped. However, in the long run, the firm can leave the industry. This
will happen when TR < TC.

Question 41

Shutdown examples:
If price is below AVC…
If the revenue curves and below the cost curves…

Answer 41

… producing Q (the quantity) costs (AVC) more than the revenue they earn
… P<C, he rectangle formed shows the area of loss
- so the firms shutdown in the short run