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
1️⃣ Fixed Factors of Production → Overcrowding → Inefficiency
In the short run, a firm cannot expand capital (e.g., factory space, machines).
As more workers are added, they have to share the same limited space or machinery.
This leads to overcrowding, causing workers to wait for equipment or get in each other’s way.
As a result, each additional worker contributes less to output, reducing MP.
2️⃣ Declining Capital-to-Labour Ratio → Less Effective Use of Capital
At first, adding workers allows for better use of machinery (e.g., reducing idle time).
However, beyond a certain point, too many workers are using the same fixed capital.
Each worker has less access to equipment, reducing their efficiency.
This leads to a fall in MP, as extra workers add less additional output.
3️⃣ Specialisation Becomes Less Effective → Productivity Falls
Initially, specialisation allows workers to become more efficient.
However, once all possible gains from specialisation are achieved, extra workers add less value.
Instead of improving productivity, additional workers start duplicating tasks or working at a slower rate.
This reduces the extra output per worker, causing MP to decline.
4️⃣ Fatigue & Diminishing Worker Efficiency → Lower Marginal Returns
As production increases, workers may experience fatigue or stress from high workloads.
Mistakes become more common, slowing production and lowering the effectiveness of each extra worker.
Even with the same number of hours worked, diminished energy and focus reduce productivity.
This leads to a decline in MP, as each additional worker produces less output.
5️⃣ Coordination & Communication Issues → Lower Productivity
As the workforce grows, it becomes harder to manage and coordinate employees effectively.
Supervisors and managers struggle to provide instructions efficiently, causing delays and confusion.
Workers spend more time waiting for orders or clarifications, slowing down production.
Poor coordination reduces output per worker, leading to a fall in MP.
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.
external eos
1️⃣ Improved Supply Chains → Lower Input Costs → Lower Unit Costs
As an industry expands, suppliers of raw materials and components increase production.
This leads to bulk-buying discounts and greater competition among suppliers, reducing costs.
Firms can source inputs at lower prices, decreasing their average costs of production.
Example: The automobile industry benefits from specialised parts suppliers producing cheaper, high-quality car components, reducing costs for all manufacturers.
2️⃣ Industry Cluster Formation → Knowledge Spillovers → Increased Productivity
Firms in the same industry cluster together in a particular region.
This encourages knowledge-sharing and innovation, as employees and ideas move between firms.
Firms become more efficient and productive, lowering their costs per unit.
The industry grows faster, attracting even more investment and skilled workers.
3️⃣ Skilled Labour Pool Grows → Lower Recruitment & Training Costs → Productivity Gains
A growing industry attracts more skilled workers, increasing the supply of specialist labour.
Firms spend less on training, as workers already possess relevant industry skills.
A larger skilled workforce boosts productivity and reduces labour costs per unit of output.
This makes the industry more competitive, reinforcing further growth.
4️⃣ Infrastructure Improvements → Lower Transportation & Communication Costs
Governments and private firms invest in better roads, ports, and digital networks as industries grow.
This lowers transport costs, making it cheaper to move goods and materials.
Faster and more reliable communication improves coordination within supply chains.
Firms benefit from greater efficiency, reducing wasted time and production costs.
5️⃣ Financial & Legal Services Develop → Easier Access to Capital → Industry Expansion
As industries grow, banks and legal firms specialise in financing and advising those sectors.
Firms gain easier access to loans and investment, supporting expansion.
Specialised legal expertise helps businesses navigate regulations more efficiently.
Lower financial and compliance costs improve firms’ profitability and competitiveness.
