4.1.4 Production, Costs + Revenue

Question 1

Define Specialisation.

Answer 1

• Concentration of production on a narrow range of goods/services

Question 2

State + explain the advantages of Specialisation.

Answer 2

• Higher Output- resources purely focused on efficient production. Increased trade- need to be able to import goods that they aren’t efficient at producing. Need to be able to export good they’re good at producing, higher export revenue, higher economic growth
• Wider range of goods/services- wide range of goods/services, within narrow range they’re specialising in
• Greater allocative efficiency- overcome issue of scarcity, as resources go to companies/regions/countries that are most efficient at producing- max output, satisfy as much consumer demand as possible
• Increased productivity through better use of workers- used to max productive potential, lower CoPs- pass onto consumer via lower prices, higher quantity + quality.

Question 3

State + explain the disadvantages of Specialisation.

Answer 3

• Finite Resources- countries with over-specialisation, e.g. oil, if depleted, could spell end of business
• De-Industrialisation- country abroad becomes more efficient at production of good/service, other industry that now isn’t efficient will de-industrialise- increased unemployment
• National Interdependence- needs to be mutually beneficial trade, export surplus + import goods/services that they’re inefficient at producing- if there are international relations issues between countries, trade could be blocked off

Question 4

Define the Division of Labour.

Answer 4

• Takes place after specialisation
• Breaking down production process into separate tasks upon specialisation

Question 5

State + explain the advantages of the Division of Labour.

Answer 5

• Workers highly productive- performing same task- more efficient + productive. Drives down CoPs- passed onto consumers via lower prices, maximise output + profits
• Specialist Capital for Workers- machinery may help workers max productivity
• Lower prices, higher quantity + quality for consumers.

Question 6

State + explain the disadvantages of the Division of Labour.

Answer 6

• Demotivation of workers- doing same task- repetitive- decrease productivity
• Risk of Long-Term Unemployment- producing narrow part of good limits skills- if tech advances + replaces job- workers lose job + have little skills
• Highly Standardised Goods/Services- lose unique touch that consumers like to see.

Question 7

Define Fixed Costs (FC) + Variable Costs (VC).

Answer 7

• Fixed Costs- costs that don’t vary with the level of output, e.g. rent, salaries (on contract), interest on loans, advertising
• Variable Costs- costs that do vary with the level of output, e.g. tax, raw materials, wages, utility bills, transport costs
• Total Costs = FC + VC

Question 8

Define Marginal Costs (MC) + Average Costs (AC).

Answer 8

• Marginal Costs= Change in TC / Change in quantity. Change in costs that arises, as total quantity increases
• Average Costs= Total Costs (TC) / Total Output Quantity (Q)
• Average Variable Costs= TVC / Quantity produced

Question 9

Define Production.

Answer 9

The conversion of factor inputs (land, labour, capital + enterprise) into final output (product)

Question 10

Define Capital Intensive Production + Labour Intensive Production.

Answer 10

• Capital Intensive Production- method of production that uses high level of capital in comparison to labour.
• Labour Intensive Production- method of production that uses high level of labour in comparison to capital.

Question 11

Define + state how Productivity is calculated.

Answer 11

• Productivity- measure of efficiency of FoPs, therefore measure how much output is produced with given level of inputs (FoPs). Output per unit of input in a given time period.
• Productivity = Total output per period of time / number of units of FoPs

Question 12

Define + state how Labour Productivity is calculated.

Answer 12

• Labour Productivity- output per worker in a given time period
• Labour Productivity= Total output per Period of Time / Number of units of labour

Question 13

Define Capital Productivity + Factor Productivity.

Answer 13

• Capital Productivity- output per unit of capital
• Factor Productivity- average output for all FoPs

Question 14

Explain how Productive Efficiency for an economy occurs.

Answer 14

• Occurs when no more output can be produced from factor inputs available
• Therefore, firm/economy will be producing max possible level of output from given set of inputs (there’s no waste)

Question 15

Define Economies of Scale + Diseconomies of Scale.

Answer 15

• Economies of scale- Reduction in LRAC as output increases
• Diseconomies of scale- Increase in LRAC as output increases

Question 16

State + explain the Internal Economies of Scale.

Answer 16

Internal economies of scale- within a business’ control
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- Risk bearing- spread risk over large range of output, decreasing AC
- Financial- negotiate lower interest rates, as firm grows, due to banks having more faith in the fact that they’ll repay the money
- Managerial- employ specialist managers, boosts productivity of workers- increase Q faster than TC increases- bringing down AC.
- Technical- bringing in specialist machinery- boost productivity- increase output
- Marketing- bulk-buy advertising, e.g. magazines
- Purchasing- as firms grow, can buy in bulk- negotiate unit discounts

Question 17

State + explain the External Economies of Scale.

Answer 17

Occur outside of business, but still within industry- businesses in industry benefit, without having done anything themselves. Creates positive externalities.
- Better transport infrastructure- reduce costs as a business, cheaper to access raw materials, decrease AC
- Component suppliers move closer- cuts cost of transporting raw materials, decreases AC
- Research + Development firms move closer- can improve technology, reduce costs

Question 18

State + explain the Diseconomies of Scale.

Answer 18

(3 C’s + an M)
- Control- as firm gets larger, harder to control workforce,decrease output
- Communication- much harder to spread messages
- Coordination- difficult to make sure departments are working in the same way
- Motivation- as there are more employees, workers feel less valuable- decrease productivity.

Question 19

Define the Law of Diminishing Returns.

Answer 19

• States in the Short-Run when variable FoPs (i.e. labour) are added to a stock of fixed FoPs (i.e. land + capital) total/marginal product will initially rise + then fall.

Question 20

Define Explicit + Implicit Costs.

Answer 20

• Explicit Costs- require actual payment (include FC + VC)
• Implicit Costs- opportunity costs, profit could’ve made doing the next best alternative

Question 21

State how TFC + AFC + AVC can be calculated.

Answer 21

• TFC = TC - TVC OR TFC= AFC X Q
• AFC = TFC / Q OR AFC = AC - AVC
• AVC = TVC / Q OR AVC = AC - AFC

Question 22

Explain the TVC Curve.

Answer 22

• Output increases greater than costs initially, because there’s under-utilised capital
• After a while, law of diminishing returns sets in- decreasing productivity- steeper curve, because costs increase greater than output

Question 23

Explain what the Minimum Efficient Scale (MES) is.

Answer 23

• Lowest level of output required to exploit full economies of scale
• AC curve stops decreasing- costs can’t decrease

Question 24

Explain Increasing Returns To Scale.

Answer 24

% Change in Output > % Change in Input
- Costs are rising, but output is rising faster, AC decrease

Question 25

Explain Decreasing Returns To Scale (RTS)

Answer 25

% Change in Output < % Change in Input
- Costs are rising, but receiving less output in return, AC rising

Question 26

Explain Constant Returns to Scale.

Answer 26

% Change in Output = % Change in Input
- AC costs are flat/constant

Question 27

Explain why the ‘U-Shaped’ LRAC Curve is unrealistic.

Answer 27

• There’s no constant returns to scale
  -Unlikely in the real word for a business to hit its MES, then straight away suffer from decreasing returns to scale- Diseconomies of Scale

Question 28

Explain why the LRAC Curve can be ‘L-Shaped’ (Natural Monopoly).

Answer 28

• Natural Monopoly- very high FC, to minimise AC have to produce a huge amount of output
• LRAC Curve constantly downward sloping over an output range- potential of economies of scale very large.

Question 29

State how TR, AR + MR are calculated.

Answer 29

• TR = P X Q
• AR = TR / Q (just the price)
• MR = Change in TR / Change in Q

Question 30

Explain what the market conditions are like when there’s Perfect Competition.

Answer 30

• Many buyers + sellers (Infinite)
• Firms selling Homogenous Goods (identical)
• Firms are price takers- no ability to set their price- have to take price in market + charge that price
• No barriers to entry/exist- free movement in + out market
• Perfect information of market conditions
• Regardless of the number of units sold, they’re always going to sell them at the same price

Question 31

Explain the Market Conditions when there is Imperfect Condition.

Answer 31

• Few buyers + sellers
• Firms sell differentiated goods
• Firms are price makers- set their own price
• High barriers to entry/exist
• Imperfectly information of market conditions

Question 32

State when TR is Maximised.

Answer 32

• When MR = 0
• If MR is higher than zero- TR continues increasing
• IF MR is lower than zero- TR decreases
• Therefore, when MR is zero, TR is maximised.

Question 33

State how Profit is Calculated.

Answer 33

Profit = TR - TC
- TC includes Explicit costs (physical costs: TFC + TVC) + Implicit Costs (opportunity cost)

Question 34

Explain the difference between Economic Costs + Accounting Costs

Answer 34

• Accounting Costs- actual costs involved in production (only considers explicit costs), e.g. rent, raw materials, wages, e.t.c.
• Economic Costs- accounting costs plus opportunity costs of resources used (explicit + implicit costs), e.g. rent lost by the owner of a factory whose firm currently uses the building

Question 35

Define Normal Profit, Supernormal Profit + Subnormal Profit.

Answer 35

• Normal Profit: minimal level of profit required to keep the FoP in their current use (AR = AC)
• Supernormal Profit: any profit made above the normal profit; economic profit is positive (AR > AC)
• Subnormal Profit: economic profit is negative; below normal profit, i.e. making a loss (AR < AC)

Question 36

Explain why firms earn normal profit in the long run in a perfectly competitive market:

Answer 36

In competitive industry, where there are many firms producing homogenous goods/services, usually no barriers to entry stopping new firms entering market + thereby increasing amount of competition.
If existing firms are earning supernormal profits, such profit levels will attract other firms to enter market
so:
- supernormal profit attracts new firms to enter industry
- increases supply in industry
- shifts supply curve right
- pushes down prices
- as no firm in industry has dominant market power, all firms have to accept market prices (firms known in this case as ‘price takers’)
- brings profits back to normal level in long-run

Question 37

Explain why firms earn supernormal profit in the long run in imperfectly competitive markets.

Answer 37

With an imperfectly competitive market, we’d expect there to be some sort of barriers to entry:
- supernormal profits earned would mean other firms have incentive to enter
- barriers to entry, e.g. patents, economies of scale, e.t.c stop new firms entering
- restricts supply
- prices stay high
- firms continue to earn supernormal profits in long-run

Question 38

Explain why is profit important for firms.

Answer 38

• measure of success for business- high profits signals firm is successful
• profit is reward for entrepreneur or shareholder for taking risk + investing in business
• for large firms with shares traded on stock market, profit is essential for keeping shareholders happy + maintaining share value- reduces risk of takeover
• supernormal profit is main source of finance for I

Question 39

Explain the difference between invention + innovation.

Answer 39

• Invention being the discovery of new processes, materials or products.
• innovation being the turning of an invention into a marketable (usable) production method/product

Question 40

Explain the impact of Economies of Scale on an Industry.

Answer 40

• Fewer + larger firms in industry.
• Higher concentration ratio (measurement of total market share held by the largest firm in the market) in the industry- where a few firms hold majority of market share (sales) in industry.
• Thus, industry is more likely to be an oligopoly/monopoly (e.g. cars, electronics)
• Some industries are natural monopolies (single firm can benefit from continuous economies of scale) where AC continue to fall as firm gets bigger. Means only one firm can access lowest possible AC (e.g. rail).
• Examples: supermarkets- few large supermarkets dominate food sales in UK (Tesco, Asda, Sainsbury, Lidl + Aldi)- benefit from significant purchasing economies of scale + monopsony power over supplies such as farmers.

Question 41

Explain the impact of Diseconomies of Scale on a Firm.

Answer 41

• Higher unit costs reduce total profits. Business may then have to raise prices to cover increased costs.
• Lost competitiveness could lead to declining market share + fall in share price if business is listed on the stock market.
• Breakdowns in communication + poor worker morale may lead to reduced quality, high staff absenteeism + turnover further reducing productivity, increasing costs + reducing profit.

Question 42

Explain the impact of Diseconomies of Scale on an Industry.

Answer 42

• More firms + smaller firms in industry- more competitive market
• Reduces concentration ratio in market.
• Leads to wider choice + better services for customers.
• However, lack of economies of scale can mean prices stay high.
• Example: dentists, beauticians, + accounts all have low start-up costs (no real technical economies of scale exist in industries, customers value customer service + personalisation, can often operate as specialist within a larger industry/within an area- reduces marketing economies of scale in industries + allows for ‘niche’ businesses.

Question 43

Define Economies of Scope.

Answer 43

Occurs when it’s cheaper to produce a range of products rather than specialise in a handful of products.

Question 44

Explain how Technological Change affects Firms’ Costs of Production.

Answer 44

• Technological change reduces the costs of production for businesses- S shifts right.
• If there’s better technology, specialist capital + machinery can be brought in, achieving technical economies of scale.
• Allows specialisation + division of labour- production processes can now be broken down into production lines- improving productivity + efficiency.
• Reduction in C, but also an increase in Q- MES can take place at a greater level of output, due to the greater exploitation of economies of scale.

Question 45

Explain how Technological Change affects Efficiency.

Answer 45

• Productive Efficiency: increases, as CoPs are lower + MES is at a greater level of output
• Allocative Efficiency: whether allocative efficiency occurs depends on whether the lower costs from productive efficiency are passed onto consumers via lower prices.
• Dynamic Efficiency: occurs, as technological improvements leads to innovation, new products + services, good for consumers.

Question 46

Explain how Technological Change can influence Market Structures- Barriers to Entry.

Answer 46

• Legal: much lower- less need for physical premises (e.g. online retail)- reduces start up costs + sunk costs. If you don’t need a premises, easier to meet certain laws + regulations, if non physical premises, unlikely firm will hire as many workers- easier to meet employment law.
• Brand Loyalty + Advertising: Advertising- much easier to do, with role of internet. Social media advertising, break into markets much easier, because of internet.
• Economies of scale
• Firms have access to greater copyrights + patents, by inventing new technology- restricting completion in certain industries.
• Overall, as of technological change, barriers to entry have come down + markets have become much more competitive.

Question 47

Explain how Technological Change can influence Market Structures- Number of Firms.

Answer 47

• Depends on barriers to entry- as they’ve been reduced, more firms will be in the market, more competitive outcomes as a result.
• If barriers increased, number of firms would be less- more likely to be a monopoly outcome.

Question 48

Explain how Technological Change can influence Market Structures- Product Homogeneity.

Answer 48

• With tech change, greater variety of products + services, less homogeneity, less similarity of products.

Question 49

Explain how Technological Change can influence Market Structures- Knowledge.

Answer 49

• Tech change drastically improves knowledge.
• Role of internet improves price information for consumers.
• Producers have greater information on costs + are able to access new technologies, look at other firms’ inventions/innovations.
• Could potentially lead to more imperfect knowledge- if there’s patented, copyrights, licenses, e.t.c at play. If one firm has control over that given market.

Question 50

Explain the Impact of Technological Change on Production.

Answer 50

• Improved productivity through the use of better equipment- leads to output per worker increasing, reducing LRAC
• New methods of production which increase efficiency again reducing LRAC- known as dynamic efficiency (efficiency improves over time)
  Improved productivity + efficiency lead to improved competitiveness- means firms lower prices + compete more efficiently. This can lead to:
• Lower prices for consumers + higher standards of living (mass production leads to access to goods + services)
• Better quality products for consumers- automation reduces faults + standardises products
  However, the use of patents by firms to protect their innovations can lead to:
• Monopoly power- meaning there may be lower output + higher prices for consumers (often for a period of time until other firms catch-up)

Question 51

Explain the impact of Technological Change on Goods + Services.

Answer 51

Innovation of new products/services + application of existing technologies to new markets has to led to significant improvements for consumers including:
* Wider choice
* Improved quality of products
* Products that better meet the needs of the consumer
This has led to significant improvements in welfare for consumers. For example:
* Time Saving Devices: robotic vacuum cleaners, air fryers- giving more time for leisure
* Products that have more functions: smart phones can be used as cameras, listening to music, etc- making life easier
* Health Care: direct improvements in diagnosis + treatments for diseases (e.g. insulin pumps for diabetes)
However many of these innovations are protected through patents + access to goods can be very limited to those on low incomes (not fairly distributed)
Can also question the harmful effects of tech- e.g. environmental damage from production + consumption.

Question 52

Explain Creative Destruction.

Answer 52

• Creative Destruction: whereby innovation leads to the development of new ‘disruptive’ products + processes which displace the firms that currently dominate the market.
• Firms who previously enjoyed higher market shares see their power eroded by technological changes that create new markets/revolutionise old ones.
• Happened throughout time: e.g. email replaced post, engine replaced horse.
• Can lead to destruction of existing markets. At same time, new markets are developed.
• Firms constantly strive to create: new production processes that lower AC + improve quality, + new products that displace existing ones.
• Key to progress to capitalist economies over time.
• New technologies + innovations replace older ones.
• Profit incentive operates to encourage entrepreneurs to be innovative.
• New business opportunities are created + entrepreneurs rewarded for investment + risk-taking.