3.3 Revenues, Costs & Profits Flashcards
total revenue definition
the total value of all sales a firm incurs
total revenue equation
total revenue(TR) = selling price(P) x quantity sold(Q)
definition of average revenue
the overall revenue per unit
Average revenue equation
average revenue (AR) = TR/Q
Marginal revenue definition
the extra revenue received from the sales of an additional unit of output
Marginal revenue equation
marginal revenue (MR) = change in TR/ change in Q
in perfect competition what is the relationship between AR and MR
- AR = MR = D
- perfectly elastic
How does TR change relative to p and q
TR increases at a constant rate
in perfect competition what kind of firm is present
price taker
What are the qualities of a price taker 3
- every unit of output is sold at the same price
- a higher price would decrease sales to zero
- a lower price could result in all sellers lowering their price
in imperfect competition what kind of firm is present
price maker
What are the qualities of price maker firms
- in order to sell an additional unit output, the price (AR) must be lowered
- both AR & MR fall with additional units of sale
- TR is maximised when MR = 0
in a price maker model, what is the relationship between AR and MR
when AR falls, MR falls by twice as much
- thus the gradient of the MR curve is twice as steep as the AR curve
- AR is the demand curve
what is the total revenue rule?
- in order to maximise revenue
- firms should increase the price of products that are inelastic in demand and decrease prices on products that are elastic in demand
What are fixed costs?
costs that do not change as the level of output changes
- these have to be paid whether the output is 0 or 5000
- e.g. building rent, management salaries, insurance, loan repayments
What are variable costs?
costs that vary directly with output
- these increase as output increases and vice versa
- e.g. raw material costs, wages of workers directly involved in production
What are marginal costs?
cost of producing an additional unit of output
equation for total costs (TC)
TC = total fixed costs (TFC) + total variable costs (TVC)
equation for total variable costs
TVC = VC x Q
equation for average total costs (ATC)
ATC = TC/Q
equation for AFC
AFC = TFC/Q
equation for AVC
AVC = TVC/Q
equation for MC
change in TC / Q
What are the 4 concepts that help to provide understanding of how the cost curves are derived?
- short run
- long run
- marginal product of labour
- law of diminishing marginal productivity
What is the short run?
the period of time where at least one factor of production is fixed
what is the long run?
the period of time where all factors of production are variable
- also called planning stage as firms can plan for increased capacity and production
What is the marginal product of labour
the change in output that results from adding an additional unit of labour
What is the law of diminishing marginal productivity
in the short run, as variable factors such as labour is added to fixed facts such as capital, there will initially be an increase in productivity
what is the however point for law of diminishing marginal productivity?
however, a point will be reached where adding additional units begins to decrease productivity due to the relationship between labour and capital
what Is the relationship between diminishing marginal returns and the cost curves
as the marginal product increases, marginal costs decrease
- there is an inverse relationship
- increasing returns causes decreasing costs
how does a firm operate in the long run?
- planning to increase the scale of production
- larger scale = more output & the firm moves onto a new SRAC curve which the average unit costs are lower
- in the long run, a growing firm is likely to keep repeating this process
when do economies of scale occur
as a firm increases its scale of output in the long run, its long run average total costs will initially decrease due to the benefits it receives
during the period of economies of scale what happens to the firm
increasing returns to scale
what is increasing returns to scale
occurs when an increase in inputs leading to a larger than proportional increase in outputs
when do diseconomies of scale occur?
as a firm increases scale of output I’m the long run, its LRATC will start to increase at some point
- the reason for the increase in the LRATC are called diseconomies of scale
what does a firm face during diseconomies of scale
decreasing returns to scale
what are decreasing returns to scale
occurs when an increasing quantity of inputs lead to a less than proportional increase in the quantity output
What acronym can be used to remember the different economies of scale?
really
fun
mums
try
making
pies
what are the types of economies of scale?
- risk-bearing
- financial
- managerial
- technological
- marketing
- purchasing
what is the risk bearing economy of scale?
- when a firm becomes larger
- their production range can be expanded
- therefore they can spread the cost of uncertainty
- if one part is not successful they have other parts to fall back on
what is the financial economy of scale?
- banks are willing to lend loans more cheaply to larger firms
- they are deemed as less risky
- thus larger forms can take advantage of cheaper credit
what is the managerial economy of scale?
- larger firms are more able to specialise and divide their labour
- they can employ specialist managers and supervisors
- lowering average costs
what is the technological economy of scale?
larger firms can afford to invest in more advanced and productive machinery and capital
- lowering AC
what is the marketing economy of scale?
- 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
what is the purchasing economy of scale?
- larger firms can bulk buy
- each unit costs them less
What are the 3 diseconomies of scale?
- control
- coordination
- communication
What is the control diseconomy of scale?
- becomes harder to monitor how productive the workforce is, as the firm becomes larger
What is the coordination diseconomy of scale?
- it is harder and complicated to coordinate every worker
- as the firms become larger thousands of employees require managing
What is the communication diseconomy of scale?
workers may start to feel alienated and excluded as the firm grows
- could lead to falls in productivity and increases in AC as motivation diminishes
What is the minimum efficient scale
the lowest cost point on a LRATC curve
- represents the lowest possible cost per unit that a firm in the industry can achieve in the long run
When do external economies of scale occur?
when there is an increase in the size of the industry which the firm operates in
- the firm is able to benefit from lower LRATC generated by factors outside of the firm
What are the sources of external economies of scale?
- geographic cluster
- transport links
- skilled labour
- favourable legislation
How are geographic clusters a source of external economies of scale?
- As an industry grows, ancillary firms move closer to major manufacturers to cut costs and generate more business
- this lowers LRATC
How are transport links a source of external economies of scale?
- improved transport links develop around growing industries in order to help people get to work and improve the transport logistics
- this lowers the LRATC
How is skilled labour a source of external economies of scale?
- increase in skilled labour lower the cost of skilled labour
- decreasing the LRATC
How favourable legislation a source of external economies of scale?
- this generates significant reductions in LRATC
- because governments support certain industries in order to achieve their wider objectives
what are the explicit costs of production?
costs which have to be paid e.g. raw materials wages
what are the implicit costs of production?
opportunity costs of production
what is the opportunity cost?
cost of the next best alternative to employing the firms resources
what is normal profit?
- occurs when TR = TC
- aka breaking even
When does supernormal profit occur?
when TR = TC
When does a loss occur?
TR<TC
What is the short run shutdown point?
- in the short run, if selling price AR is higher than AVC the firm should keep producing
- when AR>AVC
- if AR = AC it should shut down
when is the long run shutdown point
- if the AR is higher than the AC the firm should remain open
- AR>AC
- if the AR =<AC the firm should shut down
