3.3 Revenues, costs and profits

Question 1

what is revenue?

Answer 1

income from selling goods and services
total revenue = quantity x price

Question 2

what is marginal revenue?

Answer 2

the change in revenue from selling one extra unit
= change in total rev/change in quantity

Question 3

what is average revenue?

Answer 3

price per unit = total revenue/quantity

Question 4

what are price takers?

Answer 4

no control over price and must accept what the price set by the market is
- operate in highly (perfect) competitive markets, price-taking firms stay horizontal as the price doesn’t need to decrease to gain sales
- perfectly elastic demand curve, taking firms

Question 5

what are price makers?

Answer 5

have the ability/power to set their own prices for the goods and services they sell
- happens in all imperfectly competitive markets
- demand curve is downward sloping

Question 6

what are fixed costs?

Answer 6

costs do not vary at all
eg
- consulting fees
- rental costs
- fixed salaries

Question 7

what are variable costs?

Answer 7

cost that relate directly to the production or sale of a product.
eg
- basic raw materials
- packaging costs
- wage costs

Question 8

how do you calculate total costs?

Answer 8

total fixed costs + total variable costs

Question 9

how do you calculate marginal costs?

Answer 9

change in total cost/change in total quantity

Question 10

how do you calculate average costs?

Answer 10

total Cost/output

Question 11

what is marginal product?

Answer 11

the additional output produced when an extra worker (or other factor of production) is employed

Question 12

what is the average product (same as productivity)?

Answer 12

total output/total no. of workers

Question 13

what are diminishing returns?

Answer 13

increasing input after an optimal capacity has been reached (only happens in short run)
- at least one production variable is kept constant, such as labour or capital. ➡️ eventually an increase in the input will result in smaller increases in output
- explains the shape of the SRAC curve

Question 14

what causes shifts in the short term cost curve?

Answer 14

• changes in unit cost of production
• a fall in the exchange rate
• technological advancements
• entry of new products into the market
• favourable weather conditions
• taxes, subsidies and government regulations

Question 15

how does a rise in fixed costs affect the supply curve?

Answer 15

costs will only shift the AC curve and not the MC curve; a change in variable costs will shift both
- upward shift in AC

Question 16

how can the govt affect businesses fixed prices?

Answer 16

• changed in VAT
• environmental taxes
• changes in market labour intervention, minimum wage
• govt subsidies targeting producer

Question 17

in the short run what is the marginal product curve?

Answer 17

at least one factor of production is fixed, when more and more variable factors are added eventually less extra will be produced with the addition of the extra variable factor of production

Question 18

what are economies of scale?

Answer 18

advantages that arise for a firm because of its large size, or scale of operation ➡️ a fall in average costs

Question 19

examples of internal economies of scale?

Answer 19

• purchasing bulk
• technical
• managerial
• marketing
• financial options avaliable
• risk bearing
• social and welfare

Question 20

what are diseconomies of scale?

Answer 20

inefficiencies that can creep in when a firm operates on a larger scale, these factors lead to a rise in average cost s

Question 21

example of diseconomies of scale?

Answer 21

• lack of motivation, more difficult for managers in larger firms to develop the right kind of relationship
• poor communication
• co-ordination

Question 22

long run average cost and economies of scale?

Answer 22

economies of scale are when long run average costs fall as output rises
- these lower costs represent an improvement in productive efficiency + can either lead to lower prices for consumers or higher profits
- as all factors of production are variable the scale of production can change
➡️ as long as the long run average total cost curve is declining, then internal economies of scale are being exploited by the business

Question 23

what are technical economies of scale?

Answer 23

• expensive capital inputs, investment in technical equipment to improve efficiency
• specialisation of the workforce, bigger business = more staff = more money for specialists
• law of increased dimensions (container principle, important in energy sectors, office rental and warehousing) where doubling areas can cause more increase in cubic capacity
• learning by doing, production experience leads to reduced costs

Question 24

what are marketing economics of scale?

Answer 24

• in large firms costs like advertising have a less sign. impact
• can purchase factor inputs in bulk at lower prices (monopsony power)

Question 25

what are managerial economies of scale?

Answer 25

- division of labour where firms employ specialists to supervise production systems - better management can aid productivity

Question 26

what are financial economies of scale?

Answer 26

- the financial markets usually think larger firms are more credit worthy and so have access to much larger funds - smaller firms often pay higher interest rate on overdrafts and loans + find it harder to raise money on the stock market

Question 27

what are network economies of scale?

Answer 27

high fixed costs of establishing a network, the more users there are the lower are the fixed costs per unit - as a network expands, not only are there gains from extra revenues, but the long run cost per user diminishes ➡️ this is an internal economy of scale and a key factor behind the profitability of network businesses

Question 28

what are external economies of scale?

Answer 28

change outside the business which lead to a fall in average costs as an industry grows - the entire LRAC curve will shift down

Question 29

examples of external economies of scale?

Answer 29

- university research helping research funding - transport lowing logistic costs - relocation of suppliers to the centre of production - influx of human capital

Question 30

what are external dis-economies?

Answer 30

as the industry grows demand for its suppliers will increase and pulls prices upwards

Question 31

what do diseconomies of scale mean?

Answer 31

- a business has moved beyond its optimum size - localisation of businesses leads to increased demand for transport ➡️ transport cost rises - comp among firms for the factors of production + raw materials ➡️ raises the price of raw materials and other factors of production

Question 32

causes of diseconomies of scale?

Answer 32

- control and communication problems - co operation problems - negative effects of internal corporate politics - result from a business expanding beyond an optimum size and losing productive efficiency

Question 33

consequences of diseconomies of scale?

Answer 33

- rise in a firm’s long run average cost of production - higher long run average costs will reduce the profitability of a business if their prices remain the same

Question 34

what is the minimum efficient scale?

Answer 34

the scale of production when internal economies of scale have been completely exploited - MES corresponds to the lowest level of output at which the lowest point on a firm LRAC reaches

Question 35

what causes a business to have a high minimum efficient scale?

Answer 35

- fixed costs of setting up a business is hard - the cost of supplying to new customers is relatively low to fixed costs eg - gas, and water suppliers

Question 36

what is normal profit?

Answer 36

the minimum profit needed to keep factor inputs in their current use in the long run - AR= AC

Question 37

what is supernormal profit?

Answer 37

when AR > AC

Question 38

how can you increase profits?

Answer 38

- reduce overhead costs - increase labour productivity - move up the value chain - develop new products with a lower price elasticity of demand and higher income elasticity of demand - discount prices if the business estimates that demand is highly price elastic - find new customers in new markets

Question 39

when are profits maximised?

Answer 39

profits are maximised at an output level where marginal revenue (MR) is equal to marginal cost (MC)

Question 40

short-run profit diagram?

Answer 40

a firm will supply their products as long as price per unit is greater than or qual to average variable cost➡️ because there is a contribution being made to covering the fixed costs of production

Question 41

long run profit diagram?

Answer 41

a business needs to make at least normal profit in the long run to justify remaining in an industry - firms can survive while making a loss because the managers are satisficing, or where a downturn is seen as temporary and demand is expected to pick up again

Question 42

what are returns to scales?

Answer 42

how the output of a business responds to changes in inputs constant returns = increasing inputs leads to an equivilent increase in outputs

Question 43

what is long run production?

Answer 43

- all factors of production are variable - in the long run, businesses will be looking for a way to combine labour and capital to maximise productivity and reduces unit costs to their lowest possible level

Question 44

what are increasing returns to scale?

Answer 44

% change in output> % change in input

Question 45

what are decreasing returns to scale?

Answer 45

% change in input> % change in output

Question 46

what are constant returns to scale?

Answer 46

% change in ouput = % change in input

Question 47

analysis for long run average cost curve?

Answer 47

- all factors of production are variable meaning the scale of production can change - economies of scale exist when long-run average costs fall as output rises - the lower costs represent an improvement in productive efficiency and can give a business a competitive advantage in a market