Business growth - Costs

Question 1

what is the law of diminishing returns

Answer 1

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

Question 2

marginal product equation

Answer 2

change in total product / quantity

Question 3

what is average product

Answer 3

total product / quantity

Question 4

why does marginal product increase to a certain point

Answer 4

• 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

Question 5

why does MP decrease after a certain point

Answer 5

• 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

Question 6

why is total product maximised when MP = 0

Answer 6

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

Question 7

what is short run
what is long run

Answer 7

short run - when there is at least one fixed factor of production
long run - when all factors of production are variable

Question 8

what are explicit costs

Answer 8

cost that require actual payment

Question 9

what are implicit costs

Answer 9

opportunity costs

Question 10

what are fixed costs + examples

Answer 10

• costs that do not change with output
  eg rent, interest, salaries, advertising, business rates

Question 11

variable costs + examples

Answer 11

wages, utility bills, raw material costs , transport costs

Question 12

variable costs + examples

Answer 12

wages, utility bills, raw material costs , transport costs

Question 13

total fixed costs =

Answer 13

total costs - total variable costs
OR
average fixed costs x quantity

Question 14

average fixed costs =

Answer 14

total fixed costs \ quantity or average costs - average variable costs

Question 15

average variable costs =

Answer 15

total variable costs / quantity
OR
average costs - average fixed costs

Question 16

average costs =

Answer 16

total costs / quantity

Question 17

marginal costs =

Answer 17

change in total costs / change in quantity

Question 18

what is marginal cost

Answer 18

extra cost when we produce one more unit of output

Question 19

why does the MC initially decrease

Answer 19

• increased labour productivity, efficiency, output

Question 20

why does marginal costs increase after a certain time

Answer 20

law of dmr

Question 21

what are returns to scale

Answer 21

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)

Question 22

meaning of increasing, decreasing and constant returns to scale

Answer 22

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

Question 23

what is the minimum efficiency scale on a LRAC curve

Answer 23

• the lowest level of output required to exploit full economies of scale
• costs cant get any lower

Question 24

Describe the LRAC curve

Answer 24

• firm benefits from economies of scale
• firm reaches minimum efficiency scale(costs cant get any lower)
• firm experiences diseconomies of scale

Question 25

what is Eos

Answer 25

A reduction in LRAC as output increases

Question 26

internal economies of scale

Answer 26

• 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

Question 27

external economies of scale

Answer 27

• 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

Question 28

what is diseconomies of scale

Answer 28

• an increase in LRAC as output increases

Question 29

4 major diseconomies of scale

Answer 29

• 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

Question 30

Diminishing marginal productivity of labour

Answer 30

occurs when adding additional workers to a fixed factor of production leads to a decrease in additional output per worker

Question 31

what is meant by a zombie company

Answer 31

a company which is not productive on the one hand, nor seeking to enter formal insolvency proceedings,

Question 32

what does it mean to nationalise a firm

Answer 32

refers to the action of a government taking control of a company or industry

Question 33

what are the principals
what are the agents

Answer 33

• principals are the owners of a business
• agents are people who run the businesses like managers

Question 34

the principal agent problem

Answer 34

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

Question 35

overcoming the principal agent problem

Answer 35

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.