Chapter 11: Costs, economies of scale, revenue and profit Flashcards
Define firm
An organization that produces output (a good or service)
Describe firms
They range from sole traders to large companies and vary in size from local concerns to large multinational corporations operating in global markets
Define short run
The period in which at least one factor of production is fixed in supply
Define long run
The period over which the firm is able to vary the inputs of all its factors of production
Define law of diminishing returns
A law stating that if a firm increases its inputs of one factor of production while holding inputs of the other factors fixed, eventually the firm will get diminishing marginal returns from the variable factor
Define marginal physical product of labor
The additional quantity of output produced by an additional unit of labor input
Define total cost
The sum of all costs that are incurred in producing a given level of output (including opportunity cost)
Define average cost
Total cost divided by the quantity produced sometimes known as unit cost
Define marginal cost
The cost of producing an additional unit of output
Define fixed costs
Costs that do not vary with the level of output
Define variable costs
Costs that do vary with the level of output
Define sunk costs
Costs incurred by a firm that cannot be recovered if the firm ceases trading
Define economies of scale
Occur for a firm when an increase in the scale of production leads to production at a lower long-run average cost
Define internal economies of scale
Economies of scale that arise form the expansion of a firm
Define external economies of scale
Economies of scale that arise from the expansion of the industry in which a firm is operating
Define diseconomies of scale
Occur for a firm when an increase in the scale of production leads to higher long-run average costs
Define the minimum efficient scale
The level of output at which long-run average cost stops falling as output increases
Define total revenue
The revenue received by a firm from its sales of a good or service - it is the quantity sold, multiplied by the price
Define average revenue
The average revenue received by the firm per unit of output - it is total revenue divided by the quantity sold
Define marginal revenue
The additional revenue received by the firm if it sells an additional unit of output
Define normal profit
The return needed for a firm to stay in a market in the long run
Define supernormal profit
Profit above normal profits - also known as abnormal or economic profit
Define accounting profit
Profit made by a business based on explicit costs incurred but excluding opportunity cost
Define shut-down price
The price below which a firm will choose to exit the market because it is not able to cover its fixed costs
Apply the concept of the margin to societal decisions (4)
- A firm will only take on an extra worker if the benefit of employing them is greater than or equal to the wage paid
- When externalities are present - say a factory produces goods, but in so doing creates atmospheric pollution
- It should produce where MSB = MSC
- Beyond this point the MSC > MSB so the production of extra units would make society worse off
Name 5 assumptions of marginal utility theory
- Consumers are rational
- Utility can be described in cardinal terms
- Constant prices and incomes
- Goods can be split up into small units
- Marginal utility and diminishing marginal returns
Name 6 limitations of marginal utility theory
- Difficulty evaluating utility
- Consumers don’t have time to work out marginal utility/price
- Consumers are not always rational
- Numerous goods
- Many goods are related
- Often goods can’t be split into small portions
Why is the average revenue curve also the demand curve?
Because it shows the relationship between average price and quantity sold
Explain the relationship between revenue and price elasticity (5)
- When the price received by a firm is constant, the AR and MR curves are identical and horizontal. This means that PED = infinity (perfectly elastic)
- Usually as price falls, sales increase and AR is downwards sloping
- Top half of AR curve is price elastic and bottom half is price inelastic
- Total revenue increases as quantity demanded increases over the top half of AR curve. Total revenue will fall as quantity demanded increases over the bottom half of the AR curve
- The slope of the MR curve is twice as steep as the AR curve
Draw a diagram illustrating costs in the long run
Check diagram sheet
Analyze the costs in the long run diagram (4)
- If a firm wants to increase its output from q1 to q2 with a fixed factor of production, it would remain on SRAC with an average cost of B
- In the long run it can increase its fixed factor of production to produce more
- This will move the firm onto a new SRAC curve, SRAC2 where the average cost of q2 is C
- LRAC is an envelope of all the associated SRAC curves as the LRAC is either equal or less than the relevant SRAC
When are internal economies of scale experienced?
When the firm expands to move onto a new lower SRAC curve
When are constant returns to scale experienced?
When the firm expands it moves onto a SRAC at the same level
When are internal diseconomies of scale experienced?
When the firm expands it moves onto a higher SRAC curve
Name 6 types of internal economies of scale
- Purchasing
- Managerial
- Marketing
- Financial
- Technical
- Risk-bearing
Name 4 types of technical economies of scale
- Specialisation
- Indivisibilities
- Overhead
- Volume (increased dimensions)
Name 3 reasons why diseconomies of scale may occur
- Poor communication and coordination
- Low morale - employees may feel alienated as the company grows so they may be less productive
- A lack of control
Draw a diagram illustrating external economies of scale
Diagram sheet
Draw a diagram illustrating the minimum efficient scale
Diagram sheet
