6EC03 - Costs & Revenues Flashcards
What is long run?
All F.O.P are variable
What is short run?
Where at least one F.O.P is fixed,
Cannot be changed even if change in demand
What is revenue?
The amount of money a firm receives,
P x Q
What is total revenue (TR)? (Also called turnover or sales revenue)
Total money received from the sale of any given quantity of output,
P x Q
What is average revenue (AR)?
Average receipts per unit sold,
AR = TR / Q,
/ : divided by
What is marginal revenue?
The addition to to revenue of an extra unit sold,
i.e the change in TR from selling one more unit
In all cases (other than under perfect competition), how do the AR & MR curves look?
Downwards sloping (as represent demand curve & need for firms to lower prices to increase sales), MR will be twice as steep as AR, So, AR = D curve & AR = P
Why do you see a horizontal AR & MR curve?
Firm is a price taker operating under conditions of perfect competition
What does it mean when the price received by a firm for a good is constant, in terms of revenue?
AR, MR & D-curves for the good are constant,
They’re horizontal,
PED for the good is perfectly elastic,
Whatever %QD for the good there’s no change in price
If PED is inelastic, a rise in price will do what to the total revenue?
Increase TR for a firm or firms,
As use in total spending by consumers
If PED is elastic, a % rise in price will do what to total revenue?
TR will fall,
As an even larger % fall in QD will occur
What are the 2 types of costs?
Fixed costs,
Variable costs
What are fixed costs? (Indirect or overhead cost)
Costs that don’t change with output,
Only apply when at least 1 F.O.P is fixed,
Occurs only in SR,
e.g supermarket on one piece of land has fixed supply by in LR can buy land adjacent to site,
Therefore all F.O.P variable in LR
What are variable costs? (Direct or prime cost)
Costs that change with output,
Occur in SR & LR
e.g firms raw material costs so if a car Toyota makes more cars, it will use more steel
What does marginal mean?
Extra
What is average cost?
Average cost of production per unit,
AC = TC / Q,
AC = AVC + AFC
What are costs?
Expenses of the business,
Represent the value of inputs used up
What are some examples of costs?
Materials, Labour, Depreciation of equipment, Cost of capital, Opportunity of capital
What are average fixed costs (AFC)?
AFC: FC / Q
What happens to AFC as output increases? And why?
AFC always falling,
Because the FC is being spread across a greater output
What is total cost (TC)?
The cost of producing any given level of output
TC = TVC + TFC
What are average variable costs (AVC)?
AVC = VC / Q
What are marginal costs (MC)?
MC = change in TC / change in Q,
Cost of producing an extra unit of output
Where does the MC curve go through? And why?
Minimum point of the AVC & ATC curves,
Because if the marginal < average then average will fall,
So if MC > AC then average is rising
When is the only time average isn’t falling or rising?
When MC = AC & average has stopped falling & yet to start rising
What is the very long run?
State of technology can change
e.g paper statements to online banking
Explain the law of diminishing returns.
As additional units of a variable factor (e.g labour) is added to a fixed factor (e.g capital), the extra output of the variable factor will eventually diminish
Note: total output still increasing but at diminishing rate
What are the 3 assumptions of the law of diminishing returns?
1) At least 1 factor is fixed
2) Each unit of variable factor is the same (e.g each worker is equally trained)
3) Level of technology is held constant
Explain the shape of the AC curve in terms of diminishing marginal returns and economies of scale.
Slope downwards because of increasing returns to a fixed factor,
As greater inputs are added to a fixed factor e.g shop or factory floor, the firm will increase output at a faster rate,
Therefore AC will fall.
However, beyond lowest point of AC & AVC firm begins to experience diminishing returns to a fixed factor,
Therefore as additional F.O.P are added to a fixed factor, they start to add less than the last total output & AC & AVC start to increase
What are economies of scale?
Where LRAC fall,
In LR there are no fixed costs, all costs are variable,
Cannot be law of diminishing returns
What are internal economies of scale?
Economies of scale which arose because of the growth in the scale of production within a firm
What are the 5 internal economies of scale?
1) Financial economies
2) Risk-bearing economies
3) Marketing economies
4) Managerial economies
5) Technical economies
Explain managerial economies of scale.
Number of managers needed by a firm doesn’t increase at same rate as output (normally),
This lowers cost of management per unit,
As firm grows usually develop specialist management jobs,
Leading to better decision-marking & increased efficiency
Explain financial economies of scale.
Larger firms are often able to borrow money at a cheaper rate,
Because have more assets and are less risky to lend to them
Explain risk-bearing economies of scale.
Diversifying into several regions or countries,
Firm likely to have more stable demand patterns,
Sudden fall in demand in one country likely offset increase in demand in another country,
Result: demand more predictable,
Therefore firm don’t need to hold as much stock just in case,
Reduces stockholding costs
Explain marketing economies of scale.
Costs of advertising & promotion can be spread over more units as business grows,
So cost per unit falls
Explain technical economies of scale.
1) Specialisation - lead to higher productivity through repetition
2) Indivisibilities - some equipment can’t be split easily e.g production line if used for few units cost per unit high, if used on large scale to fill capacity cost per unit will fall
3) Increased dimensions - container doubled in size then volume will more than double, making storage costs cheaper per unit
4) Linked processes
What are external economies of scale?
Falling AC of production shown by downward shift in AC curve,
Results from growth in size of industry within which a firm operates,
Impacts entire industry
Give examples of external economies of scale.
Industry may benefit as result of innovations produced by other firms,
Development of new roads & transport links benefit retailers close to each other,
Group of small businesses able to share administrative & secretarial facilities
What are diseconomies of scale?
Rise in LR AC of production as output rises
Give examples of diseconomies of scale.
Growth of industry bids up prices of inputs making it more expensive for all firms,
Poor communications,
Low morale; employees may feel alienated as the company goes & gap between ‘top’ & ‘bottom’ grows,
Lack of control
X-inefficiency - lack of competition for large firm may mean costs allowed to rise
What is efficiency?
How well resources are used,
That is, the output relative to some other factor such as cost of resources used
What is productive efficiency? And where does it occur?
Occurs at lowest cost let unit of output,
Minimum point on ATC/AC curve,
Firm producing as much as possible relative to inputs
What is allocative efficiency?
When cost of production & demands of consumers taken into account to maximise welfare,
P = MC,
Where price charged for last unit is equal to cost of making last unit,
What is x-inefficiency? And how does it occur?
When a firm operates within rather than on its average cost boundary,
When costs rise because there’s no competition
What is normal profit?
Profit that the firm could make by using its resources in their best best use,
An economic cost
What is an economic cost?
The opportunity cost of an input to the production process
What is profit?
The difference between revue and costs
What is abnormal/ supernormal profit?
The profit over and above normal profit
What is a price taker?
Price taker has to offer its product at the same price as everyone else
What is a price maker?
Price maker is a firm with such a powerful position in the market that it can set prices
What is marginal profit?
The extra profit gained from selling one more unit,
MP = MR - MC
When do losses occur?
When revenue is less than cost
Why do firms stay in the industry in the SR even if they are making losses?
In SR fixed costs must be paid even if firm closed down,
e.g if output zero firm may be committed to paying rent,
Therefore if firm stops production, will make loss equal to fixed costs,
If it produces it starts to incur variable costs,
Provided the revenue can pay for variable costs it’s worth producing,
If the revenue more than covers variable costs, the firm is gaining a contribution to fixed costs,
i.e loss by producing < loss of closing down
