7.5 Types of cost, revenue and profit, short run and long run production

Question 1

What is the short run?

Answer 1

This is where at least one variable is fixed

Question 2

What are fixed and variable rates of production?

Answer 2

In the short run, the scale of production is fixed
In the long run, the scale of production is flexible

Question 3

What is marginal product? Calculation

Answer 3

It is the extra output derived per extra unit of the factor employed

MP = Change in total products / Change in number of inputs

Question 4

What is the average product? Calculation

Answer 4

It is the output per unit of input

AP = Total product / number of input

Question 5

What is the total product?

Answer 5

It is the total output produced by a number of units of factors over a period of time. The amount of capital is fixed

Question 6

What is the law of diminishing returns?

Answer 6

It only occurs in the short run.
The law states that in the short run when variable FOPs are added to a stock of fixed FOPs, the total/marginal product will initially rise and then fall
This can be due to a decrease in labour productivity or constrained production

Question 7

What is the definition and calculation of total cost? (TC)

Answer 7

They are how much it costs to produce a given level of output. An increase in output leads to an increase in total costs.
Total costs = Total variable cost + Total fixed costs

Question 8

What is the definition and calculation of total fixed costs? (TFC)

Answer 8

In the short run, at least 1 FOP can’t change. Fixed costs don’t vary with output. So even if nothing is being produced, a business has to pay these

Rent, Salaries, Interest on loans, advertising
On a cost and output diagram it will be a straight line

Calculation is TFC = Total costs - Total variable costs

Question 9

What is the definition and calculation of total variable cost? (TVC)

Answer 9

In the long run, all factor inputs change. For example, the production process might move to a new factory which isn’t possible in the short run.

Variable costs change with output. You pay more of these as your output increases
Wages, Raw materials, utility bills, transport costs…..

Wages are more flexible than salary as they can change very quickly which makes them a variable cost

TVC = Total costs - Total variable costs

Question 10

What is the calculation of Average total cost? (ATC)

Answer 10

ATC = Total costs / Quantity produced
= TC / Q

ATC = Average variable cost + Average fixed cost
= AVC + AFC

Question 11

What is the calculation of Average fixed cost? (AFC)

Answer 11

AFC = Total fixed cost/quantity
= TFC / Q

OR AC - AVC

Question 12

What is the calculation of Average variable cost? (AVC)

Answer 12

AVC = Total variable costs/quantity
= TVC / Q

Or AC - AFC

Question 13

What is the marginal cost calculation? (MC)

Answer 13

MC = Change in Total costs/change in quantity
= Change in TC / Change in Q

Question 14

What is the explanation of the shape of the SRAC?

Answer 14

Due to the law of marginal diminishing productivity, when you add more units of a variable input to a fixed input, it increases output at first. However, after a certain number of inputs are added, the marginal increase of output becomes constant. Then, when there is an even greater output, the marginal input starts to fall.

In other words, at some point in the production process, adding more inputs leads to a fall in marginal output. This could be due to labour becoming less efficient and less productive.

The line starts with a slow rise but then gets slightly steeper.

Question 15

What does the cost curve diagram look like?

Answer 15

This shows the MC (Nike sign) ATC AVC all rise with diminishing returns. However, AFC keeps falling with increasing output as it is fixed and won’t change.

The MC curve cuts through the lowest points on the ATC and AVC curves

Question 16

What does the long - run production function contain?

Answer 16

Returns to scale
No fixed FOPs (allows stuff you can’t do in the short run e.g. new technology)

Question 17

What is returns to scale?

Answer 17

Returns to scale refers to the change in output of a firm after an increase in factor inputs.

Returns to scale increase when the output increases by a greater proportion to the increase in inputs. For example, if input doubles, and output quadruples, there is said to be increasing returns to scale

Question 18

What is the reason behind the LRAC curve shape?

Answer 18

U shape

1) Business is benefiting from increasing returns to scale
2) Constant RTS
3) Decreasing RTS

Economies of scale means increasing RTS and vice versa for diseconomies of scale. There are the reasons why a firm can face different types of RTS. Minimum efficient scale is the lowest level of output required to exploit full economies of scale. After the MES point you get constant returns to scale and then increasing returns to scale which is caused by diseconomies of scale

The first half is when firms take advantage of economies of scale and average costs fall. Then it meets the Minimum efficient scale where you get a constant return to scale. After this point average costs rise due to diseconomies of scale.

Question 19

What is the minimum efficient scale?

Answer 19

This is at the lowest point on the LRAC curve. Minimum efficient scale is the lowest level of output required to exploit full economies of scale

Question 20

What is internal economies of scale?

Answer 20

This occurs when a firm becomes larger. They are all within a businesses control and they can expoloit them as businesses become larger

Question 21

What mnemonic will help you remember examples of internal economies of scale?

Answer 21

LRAC decreases as output increases.

Really Fun Mums Try Making Pies - these will all link to lower AC/ Total costs will be rising but quantity rises much faster

Risk bearing - When a firm becomes larger, it can expand its production range and diversify. Thus, they can spread the cost of uncertainty

Financial - Banks are willing to lend loans more cheaply to larger firms because they are deemed less risky. Thus, larger firms can take advantage of cheaper rate of interest.

Managerial - Larger firms are more able to specialise and divide their labour. They can employ specialist managers and supervisors which will boost productivity and lower the average cost

Technological - Larger firms can afford to invest more in advanced and productive machinery and capital, which will lower their average costs. Also employing more workers as the firm gets larger due to this technology and then making these workers specialise

Marketing - Larger firms can bulk buy, so the average cost of advertising per unit is less than that of a smaller firm.

Purchasing - Larger firms can bulk buy, which means each unit will cost them less through things like unit discounts

Question 22

What is external economies of scale?

Answer 22

Businesses in the industry can benefit without doing anything. Total costs fall

For example, local roads might be improved, so transport costs for the local industries will improve. Makes cheaper to sell goods and access raw materials and components
Component supplies could move closer to you which will reduce costs of transportation
More training facilities which will also lower average costs for firms in the local area
R&D firms will move closer which will improve tech and reduce costs

Question 23

What is diseconomies of scale?

Answer 23

These occur when output passes a certain point and LRAC increases as output increases. TC rising faster than quantity

Control - It becomes harder to monitor how productive the workforce is, as the firm becomes larger. If workers know managers aren’t really looking at them then they will slack off

Coordination - It is harder to coordinate every worker when there are thousands of workers.

Communication - Spreading messages gets hard from the top to the bottom and vice versa. This impacts productivity

Motivation - Workers feel less valued which causes productivity to drop. Tiny piece in a large puzzle

Question 24

How to calculate Total revenue? (TR)

Answer 24

Total revenue = Price x quantity
TR = P x Q

Revenue depends on the type of competition

Question 25

How do you calculate average revenue? (AR)

Answer 25

It is the average revenue per unit. AR is just price

AR = TR / Quantity sold

which means it is just price once u calculate it

Question 26

How do you calculate marginal revenue? (MR)

Answer 26

It is the extra revenue earned from the sale of one extra unit.
MR = Change in TR / Change in Q

Question 27

What is the definition of profit?

Answer 27

Total revenue - Total costs

You can have physical costs (explicit) like TFC and TVC and/or opportunity cost (implicit)

Question 28

What is normal profit?

Answer 28

It is the minimum reward required to keep entrepreneurs supplying their enterprise.
Minimum profit required to keep FOP’s in their current use
It covers the opportunity of investing their funds into the firm and not elsewhere.
This is when AR = AC. Normal profit is considered to be a cost, it is included in the costs of production.

Question 29

What is subnormal profit?

Answer 29

Subnormal profit - any profit less than the normal profit. If the problem persists then the firm will leave the industry and go into one that will make a profit. This is where AR < AC

Question 30

What is supernormal profit? (abnormal)

Answer 30

This is the profit above normal profit. This exceeds the value of the opportunity cost of investing funds into them. This is when
AR > AC

Question 31

What are explicit and implicit and explicit costs

Answer 31

Explicit costs are the fixed costs and variable costs (costs that require actual payment)
Implicit cost is the value of the opportunity costs

Question 32

What are the characteristics of a perfect market and how does it effect MR and AR curves

Answer 32

1) Many buyers and sellers (infinite)
2) Homogenous goods
3) Price takers
4) No barriers to entry and exit
5) Perfect information

In perfect comp AR = MR = D
this is as their is a fixed prices of the good because firms are price takers

Question 33

What are the characteristics of imperfect competition and how does?

Answer 33

1) Few buyers and sellers
2) Differentiated goods
3) Firms are price makers
4) High barriers to entry and exit
5) Imperfect information

At high prices, demand is low and at low prices demand is high. Simple law of demand. Since they are price makers