Business growth - Costs Flashcards
what is the law of diminishing returns
states that, in the short run, when factors of production are added to a stock of fixed FOP, total/ marginal product will initially rise then fall
marginal product equation
change in total product / quantity
what is average product
total product / quantity
why does marginal product increase to a certain point
- as more workers are added, they can learn and specialise in specific tasks, increasing efficiency and output per worker
- under-utilised resources like machinery are put to better use as more labour is employed, further improving mp
why does MP decrease after a certain point
- as more workers are added, the available capital gets less, each additional worker has less access to these resources, less efficiency and lower output per worker
- with too many workers, coordination/management becomes more difficult, may cause delays, communication issues, task overlap, inefficiency
- some factors remain fixed in the short run, there’s only so much that each worker can do. once optimal utilisation is reached, adding more workers contributes less to overall output
why is total product maximised when MP = 0
marginal product shows the additional output produced by one more unit of input
- when MP = 0, adding more input doesnt increase product, meaning total product has reached its maximum
- if MP becomes negative, tp is reduced
what is short run
what is long run
short run - when there is at least one fixed factor of production
long run - when all factors of production are variable
what are explicit costs
cost that require actual payment
what are implicit costs
opportunity costs
what are fixed costs + examples
- costs that do not change with output
eg rent, interest, salaries, advertising, business rates
variable costs + examples
wages, utility bills, raw material costs , transport costs
variable costs + examples
wages, utility bills, raw material costs , transport costs
total fixed costs =
total costs - total variable costs
OR
average fixed costs x quantity
average fixed costs =
total fixed costs \ quantity or average costs - average variable costs
average variable costs =
total variable costs / quantity
OR
average costs - average fixed costs
average costs =
total costs / quantity
marginal costs =
change in total costs / change in quantity
what is marginal cost
extra cost when we produce one more unit of output
why does the MC initially decrease
- increased labour productivity, efficiency, output
why does marginal costs increase after a certain time
law of dmr
what are returns to scale
refers to the changes in output resulting from a proportional increase in all inputs in the production process
- they describe how a firms output responds to scaling up or down the amount of input factors(like land or capital)
meaning of increasing, decreasing and constant returns to scale
increasing - when output increases by a greater proportion than the increase in inputs
constant - when output increases in the same proportion as inputs- eg doubling input leads to a doubling of output
decreasing - when output increases by a smaller proportion than the increase in inputs
what is the minimum efficiency scale on a LRAC curve
- the lowest level of output required to exploit full economies of scale
- costs cant get any lower
Describe the LRAC curve
- firm benefits from economies of scale
- firm reaches minimum efficiency scale(costs cant get any lower)
- firm experiences diseconomies of scale
what is Eos
A reduction in LRAC as output increases
internal economies of scale
- EOS within a business
- managerial - as a firm gets larger, they can employ specialist managers, who can monitor the productivity of the workforce and boost it
- technical - as a firm gets larger, they can bring in specialist machinery, which would increase cost in SR but boost productivity / employing more workers and making them specialise
- purchasing - as firms grow, they are able to buy their raw materials in bulk, can get unit discounts, can spread costs over a wider range of output
- marketing - as a firm grows, they can bulk buy their advertising , can negotiate better unit rates of advertising
- financial - as a firm grows, they can negotiate lower rates of interest when they loan. this is because they are profitable, reputable/lower risk
- risk bearing - as firms grow, they can spread risk (opportunity cost) over a larger range of output
external economies of scale
- don’t occur within a business, but they occur within the industry
- better transport infrastructure - new roads/railways, reduced costs for businesses
- component supplies may move closer to you - lower transport costs
- research and development firms may move closer, improve technology/dynamic efficiency and reduce costs
what is diseconomies of scale
- an increase in LRAC as output increases
4 major diseconomies of scale
- control - business grows, harder for managers to control the workforce, workers may slack off more, reduces productivity, quantity, Tc increases
- communication - harder to spread messages through the firm, wasted time may impact productivity
- coordination- harder to coordinate different parts of the business, eg it’s hard for purchasing department to work alongside marketing department, productivity falls
- motivation - more workers, workers may start to feel less valued, reduced
motivation and productivity
Diminishing marginal productivity of labour
occurs when adding additional workers to a fixed factor of production leads to a decrease in additional output per worker
what is meant by a zombie company
a company which is not productive on the one hand, nor seeking to enter formal insolvency proceedings,
what does it mean to nationalise a firm
refers to the action of a government taking control of a company or industry
what are the principals
what are the agents
- principals are the owners of a business
- agents are people who run the businesses like managers
the principal agent problem
when shareholders have different objectives than their managers
- shareholders usually want to maximise profit as they will receive higher dividends
- managers may want to maximise revenue
- the PA problem is an asymmetric problem, as the owners of a firm cannot observe day to day decisions of management
overcoming the principal agent problem
Aligning Incentives through Performance-Based Pay
- Firms often use performance-related bonuses, stock options, or profit-sharing schemes to align the interests of managers with those of shareholders
Example: In many tech companies like Google, executives receive stock options, incentivizing them to focus on long-term company growth and shareholder value.
Improved Corporate Governance and Monitoring
- Shareholders can implement robust oversight mechanisms, such as appointing independent directors, conducting regular audits, and instituting clear reporting structures.
- In the UK, the Cadbury Report
Active Shareholder Engagement
- Principals (shareholders) can actively participate in decision-making through voting rights at annual general meetings or by directly engaging with management.
- Activist shareholders like those in companies such as ExxonMobil push for sustainable practices and long-term value creation.
