3.3 Revenues, Costs and Profits

Question 1

What is revenue?

Answer 1

The money earned from the sale of goods and services

Question 2

What is total revenue?

Answer 2

The total amount of money coming into the business through the sale of goods and services. quantity x price

Question 3

What is average revenue?

Answer 3

Demand is equal to AR

Question 4

What is marginal revenue?

Answer 4

The extra revenue that the firm earns from selling one more unit of production:
total revenue from ‘N’ goods- total revenue from (N-1) goods, or:

Question 5

What does this diagram show?

Answer 5

A firm with a ​perfectly elastic demand curve

These are firms in perfect competition they have no price setting power. In this case, the price received by the firm for the good is constant and so MR=AR=D

Question 6

What do the TR, AR and MR curves look like for a firm with imperfect competition?

Answer 6

Up until output Q, the demand curve is elastic

Question 7

At what point is the demand curve inelastic?

Answer 7

After output Q, (as MR becomes negative)

Question 8

What is total cost?

Answer 8

The cost of producing a given level of output: fixed + variable costs

Question 9

What is total fixed cost?

Answer 9

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

Question 10

What is total variable cost?

Answer 10

Costs that change directly with output e.g. materials

Question 11

What is average (total) cost?

Answer 11

Question 12

What is average fixed cost?

Answer 12

Question 13

What is average variable cost?

Answer 13

Question 14

What is marginal cost?

Answer 14

The extra cost of producing one extra unit of a good:
total cost of producing N goods - total cost of producing (N-1), or:

Question 15

What is diminishing marginal productivity?

Answer 15

Diminishing marginal productivity means that 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 will decrease as more inputs are added in the short run. This will mean that the ​marginal cost of production will rise

Question 16

What does this diagram show?

Answer 16

The short run cost curves

Question 17

Explain the shape of the curves in this diagram

Answer 17

● AFC starts high because the whole fixed costs are being divided by a small output. As output is increased, AFC falls as the same amount is divided by a larger number.
● ATC is U-Shaped due to the law of diminishing marginal productivity. Costs initially fall as machinery is used more efficiently but as production continues to expand, efficiency falls as machinery is overused.
● AVC is also U-Shaped, but it gets closer to ATC as output increases since AFC gets smaller.
● MC will also be U-Shaped due to the law of diminishing marginal productivity. It will initially fall as the machines are used more efficiently but will rise as production continues to rise.

Question 18

Are average costs lower at point A or B?

Answer 18

Average costs at B are lower than at A, since the gradient of A is steeper than B. The tangent to the total cost curve is marginal cost

Question 19

Why are both SRAC and LRAC curves U-shaped?

Answer 19

● Short run average cost curves are U-Shaped because of the law of diminishing returns
● Long run average cost curves are ​U-Shaped because of ​economies and diseconomies of scale

Question 20

What do different shifts or movements of the LRAC curve show?

Answer 20

● The LRAC curve is a boundary representing the ​minimum level of average costs attainable at any given level of output. Points below the LRAC are unattainable and producing above the LRAC is inefficient.
● Movement along the LRAC is due to a ​change in output ​which changes the average cost of production due to internal economies/diseconomies of scale. A shift can occur due to external economies/diseconomies, taxes or technology, which affects the cost of production for a given level of output.

Question 21

What are economies of scale?

Answer 21

The ​advantages of large scale production ​that enable a large business to produce at a lower average cost than a smaller business. As a result, the firm is able to experience ​increasing returns to scale where an increase in inputs by a certain percentage will lead to a greater percentage increase in output.

Question 22

What are diseconomies of scale?

Answer 22

The ​disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise. The firm experiences ​decreasing returns to scale,​ where output increases by a smaller percentage than inputs

Question 23

What are constant returns to scale?

Answer 23

Where firms increase inputs and receive an increase in output by the same percentage

Question 24

What is the ​minimum efficient scale?

Answer 24

The minimum level of output needed for a business to fully exploit economies of scale. It is the point where the LRAC curve first levels off and when constant returns to scale is first met.

Question 25

What is an internal economy of scale?

Answer 25

An advantage that a firm is able to enjoy because of a growth in the firm, independent of anything happening to other firms or the industry in general

Question 26

When do technical economies of scale occur?

Answer 26

Arise as a result of what happens to the production process

Question 27

What are examples of technical economies of scale?

Answer 27

● Specialisation ● Research and development ● Balanced teams of machines ● Indivisibility of Capital

Question 28

How can specialisation lead to EOS?

Answer 28

Large firms will be able to appoint specialist workers and buy specialist machines which will be able to do their jobs more **quickly** and **better** than machines/workers which are not specialised

Question 29

How can balanced teams of machines lead to EOS?

Answer 29

Large firms can afford to buy a number of every kind of machine for each stage of production. By combining these machines, they can ensure they run each machine at its optimal level. Smaller companies may only be able to afford one machine for each stage and if one stage of production runs faster than the other, machines will spend a long time turned off

Question 30

How can indivisibility of capital lead to EOS?

Answer 30

Some processes require huge items of machinery and investment that make it only possible for them to produce on a large scale, which can reduce average costs

Question 31

How can research and development lead to EOS?

Answer 31

Often it is only large firms that can afford to carry out large scale research and development, which means they are able to gain a large advantage over their competitor.

Question 32

How can a firm benefit from financial economies of scale?

Answer 32

Large firms have greater security because they have **more assets** and are therefore less likely to be forced out of business overnight. As a result, it is **easier** for them to **obtain finance**, and **interest rates** will be **lower** due to **lower risk**. This makes **investment more accessible**

Question 33

What are risk bearing economies of scale?

Answer 33

Large companies are able to operate in a range of different markets, producing different products which means that if one area of business fails, their whole business will not collapse

Question 34

What are managerial economies of scale?

Answer 34

Large companies can afford to appoint specialist managers in every field, who are specialised and so have greater knowledge and are able to do their job better. Staff represent an indivisibility and so small firms cannot employ specialist staff

Question 35

What are some marketing and purchasing economies of scale

Answer 35

● Buying in bulk ● Specialisation ● Distribution

Question 36

How can buying in bulk lead to EOS?

Answer 36

Large firms are able to buy in large numbers so may be able to buy their raw materials at a cheaper price than competitors.

Question 37

How can specialisation (in buying and selling) lead to EOS?

Answer 37

​Like other areas, businesses can afford to take on specialist buyers and sellers who could be more efficient due to the extra time and knowledge.

Question 38

How can distribution benefit from EOS?

Answer 38

● ​Large firms are able to enjoy **preferential rates** from transport companies because they offer the company a lot of businesses. ● They will be transporting in **large batches** which means that they will be able to transport in full, large transporters which are **cheaper per item** than half-full or smaller transporters. ● Large businesses can also establish **regional distribution centres** which enables them to reduce transport costs by using large transporters over long distances, storing goods in the distribution centre and using smaller transport to take stock to individual shops

Question 39

What is an external economy of scale?

Answer 39

An advantage which arises from the growth of the industry within which the firm operates, independent to the firm itself. These cause the LRAC curve to shift downwards.

Question 40

How can firms benefit from external EOS of labour?

Answer 40

● Businesses established in an area with other successful firms from the same industry find that ​labour tends to come to that area if they want a job in that industry, for example ​Silicon Valley​. This reduces the cost and time take to recruit ● Firms will be able to hire staff who have been ​trained by other businesses​, which is cheaper and more efficient for the firm than training the workers themselves ● Another advantage for large industries is that ​local education and training providers are more likely to develop courses to prepare people to take up jobs in these businesses.

Question 41

How can firms benefit from external EOS of support services

Answer 41

Businesses who provide products or services for large businesses will naturally move to the area where those businesses are based, which reduces transport cost/time delays for the business.

Question 42

How can firms suffer diseconomies of scale from workers?

Answer 42

In a large business, people can think their efforts go unnoticed and have less chance of promotion so lose motivation and work less hard. They can also lose their sense of belonging and have less personal commitment and identification with the business.

Question 43

How can firms suffer diseconomies of scale due to geography?

Answer 43

A firm may have to transport finished products huge distances and firms may find it harder to control parts of the business which is miles away

Question 44

How can firms suffer diseconomies of scale due to the price of materials?

Answer 44

As business grows so does their demand for raw materials and equipment. Although this can increase their bargaining power as they buy in bulk, an increase in demand can cause prices to rise and therefore increase production costs. This could also occur if the whole industry increases and so firms bid up prices

Question 45

How can a firm suffer managerial diseconomies of scale?

Answer 45

● Coordination and control: As a business grows, it will become progressively more difficult. Coordination of a multinational company producing different parts of a car around the world is much more difficult than coordinating and controlling the work of a local garage. This could lead to poorer quality to work and business decisions which don’t work well together. ● Communication: ​Within a large business, communication can be slow and can lose accuracy because of the distance and the number of people it has to be passed through

Question 46

What is profit?

Answer 46

Profit is the difference between revenue and costs

Question 47

What is normal profit?

Answer 47

The ​return that is sufficient to keep the factors of production committed to the business​, to justify the firm staying in the market. If the firm covers its costs it earns normal profit. This is at the point where AC=AR or TC=TR.

Question 48

When do supernormal profits occur?

Answer 48

AR>AC or TR>TC

Question 49

When should a firm continue operating, despite making a loss?

Answer 49

If ​AVC

Question 50

When should a firm leave an industry?

Answer 50

If AVC>AR ## Footnote producing more goods will increase the loss

Question 51

In the long run what does a firm need to justify staying in the market?

Answer 51

At least normal profits

Question 52

What is the short run shutdown point for a firm?

Answer 52

Where ​AVC=AR

Question 53

Will this firm keep producing or leave the market?

Answer 53

They will keep producing. While they are making a loss of the shaded area, their AVC cost is only C2 and AR>AVC so they will continue to produce in the short run