3.3 Revenues, Costs, Profits

Question 1

What revenue

Answer 1

The money earned form the sale of goods and services

Question 2

What is total revenue and how is it calculated

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 and how is it calculated

Answer 3

Average revenue is the equivalent of price and it is also equal to the demand: total revenue/ output

Question 4

What is marginal revenue and how is it calculated

Answer 4

The extra revenue that the firm earns from selling one more unit of production:

Change in total revenue/ change in output

Question 5

Draw and explain a perfectly elastic demand curve

Answer 5

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Question 6

Draw and explain a downwards sloping demand curve

Answer 6

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Question 7

What is the elasticity of a downwards slopping demand curve linked to

Answer 7

Marginal revenue

Question 8

What does it mean if marginal revenue is positive on the ​downward sloping demand curve

Answer 8

the firm sells the product at a lower price (or when they increase output), total revenue still grows and so the demand curve is elastic​.

Therefore up until where MR=0 the demand curve is elastic

Question 9

What does it mean if marginal revenue is negative on the ​downward sloping demand curve

Answer 9

TR decreases as price decreases (or output increases) and so the demand curve is​ inelastic​.

Therefore after where MR=0 the demand curve is inelatic

Question 10

Where on the ​downward sloping demand curve is TR maximised

Answer 10

Where MR=0

Question 11

What is the economic cost of production

Answer 11

The ​opportunity cost of production​; the value
that could have been generated had the resources been employed in their next best use.

Question 12

What is the difference between short run and long run economics

Answer 12

In the short run, at least one factor of production is fixed and cannot be changed and so therefore some costs are fixed whilst in the long run, all costs are variable e.g. more property can be used so rent becomes higher.

Question 13

What is total costs and how is it calculated

Answer 13

The cost of producing a given level of output:

fixed + variable costs

Question 14

What are total fixed costs

Answer 14

Costs that do not change with output and remain constant

e.g. rent, machinery

Question 15

What are total variable costs

Answer 15

​Costs that change directly with output e.g. materials

Question 16

How are average costs calculated

Answer 16

Total costs/ out put

Question 17

How are average fixed costs

Answer 17

Total fixed cots/ output

Question 18

What are marginal costs and how are they calculated

Answer 18

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

Question 19

What is diminishing marginal productivity

Answer 19

• If a factor of production is fixed, this will ​affect the business if it decides to expand. More workers can be added relatively easily and this will see an increase in production as machinery is used more efficiently. However, it will take a long time for the factory to expand and adding more labour will mean that they will have less and less impact on the amount produced as they get in the way and have no machines to use. This is called the Law of Diminishing Returns or ​diminishing marginal productivity​.
• 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 20

Draw and explain an average fixed costs curve

Answer 20

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Question 21

Draw and explain and average total cost curve

Answer 21

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Question 22

Draw and explain an average variable cost curve

Answer 22

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Question 23

Draw and explain the marginal cost curve

Answer 23

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Question 24

Why are short run average cost curves U shaped

Answer 24

Short run average cost (SRAC) curves are U-Shaped because of the law of diminishing returns

Question 25

Why are long run average cost curves U shaped

Answer 25

long run average cost (LRAC) curves are ​U-Shaped because of ​economies and diseconomies of scale.

Question 26

Draw and explain a graphs which presents both short run cost curves and long run cost curve

Answer 26

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Question 27

What are movements on the LRAC the response to

Answer 27

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 28

What are economies of scale

Answer 28

Economies of scale are 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 29

What are diseconomies of scale

Answer 29

Diseconomies of scale are 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 small percentage than inputs

Question 30

What are constant returns to scale

Answer 30

Constant returns to scale is where firms increase inputs and receive an increase in output by the same percentage

Question 31

What is the minimum efficient scale

Answer 31

The ​minimum efficient scale is 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 32

What is are internal economies of scale

Answer 32

An internal economy of scale is 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 33

How are technical economies achieved

Answer 33

These arise as a result of what happens to the production process.

Question 34

What are examples of technical economies

Answer 34

Specialisation

Balanced teams of machines

Research and development

Increased dimensions

Question 35

What is specialisation in technical economies of scale

Answer 35

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 36

What is having a balanced team of machines in technical economies of scale

Answer 36

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 37

What are increased dimensions in technical economies of scale

Answer 37

This relates to the fact that if you double the size of the walls you can increase the area by four times, or if you double the size of a container you increase the amount it can carry by more than double. This all occurs without doubling the cost.

Question 38

What is indivisibility of capital in technical economies of scale

Answer 38

Some processes require huge items of machinery and investment that make it only possible for them to produce on a large scale.

Question 39

What is research and development in technical economies of scale

Answer 39

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 40

What financial economies of scale

Answer 40

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 41

What are risk bearing economies of scale

Answer 41

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 42

What are managerial economies of scale

Answer 42

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 43

What are some examples of marketing and purchasing economies of scale

Answer 43

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

● Specialisation: ​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.

● Distribution: ​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 44

What are external economies of scale

Answer 44

An external economy of scale is 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 45

What is labour is external economies of scale

Answer 45

● 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.

● 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.

● 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.

Question 46

What are some examples of diseconomies of scale

Answer 46

Workers

Geography

Change

Price of materials

Management

Question 47

Workers in disecomies of scale

Answer 47

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 48

Geography in diseconomies of scale

Answer 48

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 49

Change in disecomies of scale

Answer 49

It takes much longer and is much more difficult for a large firm to respond to change.

Question 50

Prices of materials in diseconomies of scale

Answer 50

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 51

Management in diseconomies of scale

Answer 51

● Coordination and control: As a business grows, it will become progressively more difficult to coordinate and keep control of all the different parts of the business. 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 also can lose accuracy because of the distance and the number of people it has to be passed through.

Question 52

When does profit maximisation occur

Answer 52

● Profit is maximised when ​TR and TC are furthest apart​, with TR above TC.
● It also occurs when ​MC=MR​: this will always be true because if producing one more adds more to revenues than it does to cost (i.e. MR is higher than MC), producing that must have increased profit and vice versa. Sometimes, MR and MC may cross at two points and thus the profit maximising point is where marginal cost rises as it
crosses the MR line.

Question 53

What is normal profit and how can it be found

Answer 53

● Normal profit is the ​return that is sufficient to keep the factors of production committed to the business​. In economics, costs include the level of profit needed to keep the producer in the market and to cover the opportunity cost. Therefore, if the firm covers its costs it earns normal profit. This is at the point where AC=AR or TC=TR.

Question 54

What happens if a firm is earning above normal profit

Answer 54

If the ​profit is greater than normal profit​, it is earning supernormal, abnormal or monopoly. This occurs where AR>AC or TR>TC.

Question 55

What does it mean if a firm is making a loss and how can it be found

Answer 55

● A loss is where the firm ​fails to cover its costs,​ AR<AC or TR<TC.

Question 56

In what condition should the firm continue production

Answer 56

● If ​AVC<AR then ​firms should continue production​. Each good they make will generate more revenue than it cost for them to make it, and so this will help them to reduce the size of the loss by covering some of the fixed cost. In this case, they should only shut down when their fixed costs increase e.g. when machinery needs to be replaced, when their lease is up etc.

Question 57

Under what condition should a firm shut down

Answer 57

​AVC>AR then producing more goods will increase the loss. As a result, they ​should leave the industry immediately​.

Question 58

Draw and explain a diagram where a firm will continue to produce goods in the short run

Answer 58

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