3.3 Revenues, Costs & Profits Flashcards
1
Q
total revenue
A
- total revenue = price x quantity sold (TR=PxQ)
- it’s the total value of sales that a firm incurs
2
Q
average revenue
A
- average revenue = total revenue / quantity (AR=TR/Q)
- it’s the overall revenue per unit
- AR is the firm’s demand curve
3
Q
marginal revenue
A
- marginal revenue = change in total revenue / change in quantity (MR=△TR/△Q)
- it’s the extra revenue recieved from the sale of an additional unit of output
- when MR = 0 total revenue is maximised
4
Q
relationship between TR, AR, and MR
A
- the relationship between these 3 is different in perfect and imperfect competition
- diagram 1
5
Q
PED and revenue
A
- diagram 2
- diagram illustrates the total revenue rule - to maximise revenue, firms should decrease prices of goods with an elastic PED, and increase prices of goods with an inelastic PED
6
Q
costs
A
- fixed costs; they don’t change as level of output varies, e.g. building rent
- variable costs; they vary directly with output, i.e. increase as output increases, e.g. raw material costs
- marginal costs; the cost of producing an extra unit of output
7
Q
total cost
A
- total cost = total fixed costs + total variable costs
- TC=TFC+TVC
8
Q
total fixed cost
A
- the costs that don’t change with output, e.g. rent, salaries, etc.
9
Q
total variable cost
A
- variable cost x quantity
- VCxQ
- the costs that vary directly with output, e.g. raw materials, wages, etc.
10
Q
average total cost
A
- average total cost = total cost / quantity
- AVC=TC/Q
11
Q
average fixed cost
A
- average fixed cost = total fixed costs / quantity
- AFC=TFC/Q
12
Q
average variable cost
A
- average variable cost = total variable costs / quantity
- AVC=TVC/Q
13
Q
marginal cost
A
- marginal cost = change in total cost / change in quantity
- MC=△TC/△Q
14
Q
short-run and long-run costs
A
- in the short-run, at least one factor of production is fixed, so there are some fixed costs
- in the long-run, all factors of production are variable, so there are no fixed costs and all costs are variable
15
Q
law of diminishing marginal productivity
A
- states that adding more units of a variable input to a fixed input increases output at first, but after a certain number of inputs are added, the marginal increase in output becomes constant, and when even greater input is added, it leads to a fall in marginal increase in output (diminishing returns)
- marginal costs rise with increasing diminishing returns
16
Q
derivation of short-run cost curves from the assumption of diminishing marginal productivity
A
- diagram 3
- only operates in the short-run as that’s when fixed costs exist as at least one factor of production is fixed
17
Q
short-run and long-run costs
A
- in the short-run, at least one factor of production is fixed, so there are some fixed costs (firms have limited flexibility)
- in the long-run, all factors of production are variable, so there are no fixed costs and all costs are variable
18
Q
relationship between short-run and long-run average cost curves
A
- diagram 4
19
Q
costs - synoptic point
A
- many macroeconomic effects can affect a firm’s costs; e.g. changes in the ER, entering / leaving a customs union, and the creation/ removal of a minimum wage
- a firm’s costs has implications for the competitiveness of a country’s exports; if firms face high costs, they’re likely to increase their prices which makes a country’s exports less price competitive on the international market, ceteris paribus
20
Q
economies of scale
A
- when average costs decrease as output increases
- as a firm increases its scale of output in the long-run, it’s LRAC will initially decrease due to the benefits it receives, i.e. economies of scale
- during this period, the firm enjoys increasing returns to scale (increase in inputs for scaling up leads to a larger than proportional increase in output)
- these can be internal (occurs when a firm grows) or external (occurs when there’s growth in the industry within which the firm operates)
21
Q
diseconomies of scale
A
- when average costs increase as output increases, occurring after output passes a certain out
- as a firm continues increasing its scale of output in the long-run, it’s LRAC will start to increase at some point, i.e. due to diseconomies of scale
- during this period, the firm faces decreasing returns to scale (when increase in inputs for increasing scale of production leads to a less than proportional increase in the quantity of output)
22
Q
types of internal economies of scale
A
- occur when a firm grows
- Really Fun Mums Try Making Pies
- risk-bearing; larger firms have expanded product ranges, so they can spread the cost of uncertainty; if one part is unsuccessful, they have other parts to fall back on
- financial; larger firms can take advantage of cheaper credit, as banks are more willing to lend them cheaper loans as they’re deemed less risky
- managerial; they’re more able to specialise and divide their labour, and can employ specialist managers / supervisors which lowers average costs
- technological; they can afford to invest in more advanced and productive machinery / capital, which will lower their average costs
- marketing; they can divide their marketing budgets across larger outputs, so average costs of advertising is smaller per unit
- purchasing; they can bulk-buy, so each unit will cost them less. they have better buying power than smaller firms, so can negotiate better deals
23
Q
types of external economies of scale
A
- occur as a result of growth in the industry within which the firm operates
- transport links; as an industry expands, they gain better transport links which will improve efficiency of all firms in that area, reducing their average costs
- skilled labour; as an industry grows, so does the number of skilled workers for that industry, so a bigger pool of them makes it easier and cheaper for all firms in that industry to find workers, and no need to train them, so it reduces their LRAC
- geographic cluster; as an industry grows, ancillary firms relocate to move closer to major manufacturers to cut costs and generate more business, e.g. tech businesses in Silicon Valley in California
- research economies; the more firms in an industry, the more r&d will be conducted, which can increase productivity and reduce costs for firms
24
Q
types of diseconomies of scale
A
- occur when output passes a certain point and average costs rise as output rises
- control; it’s harder to monitor how productive the workforce is as the firm becomes larger
- coordination; it’s harder and more complicated to coordinate workers when the workforce is much larger
- communication; this can slow down and lose accuracy in a large firm due to the distance and no. of people it has to transfer through
- motivation; workers may feel alienated and excluded as the firm grows, which could lead to falls in productivity and increases in average costs as they lose motivation
- competition; a lack of competition means firms have no incentive to address inefficiencies and improve processes, leading to x-inefficiency and a rise in LR average costs
25
Q
difference between diminishing marginal returns and decreasing returns to scale
A
- diminishing marginal returns;
- only for the short-run
- occurs when increasing input (a variable FoP) after optimal capacity leads to smaller increases in output
- e.g. if a firm increased workers in a factory but there was a shortage of equipment for them to use, output can’t increase as much but the firm still incurs costs of employing the workers
- decreasing returns to scale;
- only for the long-run
- occurs when an increase in inputs for increasing scale of production and output causes an increase in long-run average costs
- e.g. if a company becomes too large, they may become inflexible and slow to respond to the market conditions, so long run average costs will increase if output increases
26
Q
minimum efficient scale
A
- diagram 5
- the lowest point on an LRAC curve; optimal level of output with constant returns to scale
27
Q
conditions for profit maximisation
A
- profit is the difference between total revenue and total cost
- it’s the reward that entrepreneurs yield when they risk take
- it occurs where marginal cost=marginal revenue; MC=MR (when each extra unit provided gives no extra loss or revenue)
28
Q
profit
A
- profit = total revenue - total costs
- total costs include explicit (easily quantifiable, e.g. raw materials) and implicit (opportunity costs) costs of production
29
Q
normal profit
A
- occurs when TR=TC / AR = AC (break-even point)
- it’s the minimum reward required to keep entrepreneurs supplying their enterprise in the long run
30
Q
supernormal profit
A
- occurs when TR > TC / AR > AC
- it’s the profit above normal profit
31
Q
subnormal profit / losses
A
- occurs when TR < TC / AR < AC
- it’s when profits are below normal profits (break-even point), so the firm fails to cover its costs
32
Q
short and long-run shutdown points
A
- when a firm shuts down in the short-run, it means production is only temporarily stopped
- in the long-run, when a firm shuts down, they can leave the industry permanently
33
Q
short-run shutdown point
A
- diagram 6
- short-run shutdown point; AR=AVC
- when a firm is making a loss, it may not necessarily be the best decision to shut down immediately; it depends on the AVC
- in the short-run, if the selling price (AR) is higher than average variable costs (AVC), the firm should keep producing
- if the selling price (AR) falls to the AVC, it should shut down, because if AVC > AR, producing more goods will increase the loss, so firms should shutdown
34
Q
long-run shutdown points
A
- long-run shutdown point; AR>AC
- when AC > AR in the long-run, the firm is making a loss and will leave the industry
- the firm can recover both fixed and variable costs in the long-run, so will exit if price is lower than AC
35
Q
why some firms won’t shut down in the short-run
A
- in real life there are some circumstances where firms will continue to produce even if AVC > AR
- if there’s a temporary fall in demand, e.g. due to a recession, a firm can prefer to keep producing so they don’t lose long-term customers
- if a firm can gain access to credit or if it has high savings, it can afford to run an operating loss for a short time
- a firm may respond to AVC > AR by trying to cut costs or increase prices, rather than by shutting down
- it may take time for a firm to revise they’re making an operating loss
- it’s also possible for a firm to shut down even if AR > AVC, e.g. if the firm is pessimistic about the growth of this particular market and feel there’s a high opportunity cost to staying in a declining industry
