Costs, revenues and profits Flashcards
How do you define short run and long run?
- Short run – the time period when at least one input factor of production is fixed. For instance, in the short run, a cafe may be able to hire more workers, but it cannot increase its building size
- Long Run – the time period in which all inputs are variable
Define total product, average and marginal product
Total Product – the total quantity of good produced; the total output
Average Product – the output produced per unit of input
AP = TP/no. of variable inputs
Marginal Product – the extra output produced per additional unit of variable input
MP = change in total product / change in variable input
describe what happens when you add more units of varibale input
Stage 1
- At first, adding more units of labour increases output because workers can specialise and be more efficient as a team
- Marginal product is increasing, meaning that the addition to total product of each additional worker gets bigger and bigger
- Total product is increasing
Stage 2
- After a certain point, output begins to increase by less and less
- Marginal product is decreasing, which means that each additional worker is now contributing less and less to the total product
- Total product still increases, but by less
Stage 3
- Eventually output starts to decrease, e.g., due to overcrowding
- Marginal product will be negative, as each extra worker is taking away from the total product
- Total product decreases
describe the relationship between marginal product and average product
- When the marginal product is above the average product, the average product is increasing
- When the marginal product is equal to AP, the average product is at its peak
- When MP is below AP, the average product decreases
Describe the law of diminishing marginal returns
- At first, as more units of variable input are added, marginal product increases
- There comes a point where adding more variable inputs causes marginal product to begin to decrease, because the gains from specialisation have already been had. For instance, workers begin to overcrowd each other, making them less effective at their jobs
- When marginal product becomes negative, average product decreases.
whats the difference between fixed and variable costs
Fixed costs – costs which don’t change as output changes. E.g., rent, machinery
Variable costs – change as output increases or decrease. The more the variable inputs a firm uses, the greater the variable costs. E.g., wages, ingredients
what are the formulas for average variable, fixed and total costs
Average variable costs = total variable costs / Q
Average fixed costs = total fixed costs / Q
Average total costs = total cost / Q
define the marginal cost
Marginal cost = the extra cost of producing one more unit of output
MC = ∆TC / ∆Q
why is AFC downward sloping
AFC slopes downwards as output increases, because the same cost is being divided by a bigger and bigger output
Why do AVC, ATC and MC all follow similar curves
AVC, ATC, MC, all follow the same general trend of sloping downwards before rising again. This is due to the concept of diminishing marginal returns
Why does the MC curve intersect the ATC and AVC curve at their minimum points?
- When your marginal cost is below your average cost, the average cost will fall
- When your marginal cost is above the average cost, your average cost will rise
- Therefore, the marginal cost must intersect the average cost where the AC curve is neither rising nor falling. Therefore, it must intersect where the gradient of the AC curve is zero, which is at its minimum point.
Define total revenue, and its formula
- The price of the good multiplied by the quantity sold
- P X Q
Define Marginal revenue, and give its formula
- the extra revenue received from selling an additional unit of output
- ∆TR / ∆Q
Define average revenue, and give its formula
- the revenue received per unit sold
- i.e., the price
- =P
why is average revenue a downward sloping curve in a monopoly
- In a monopoly, the firm is the market, therefore the market demand curve is the firm’s demand curve
- The demand curve is also the average revenue curve because it tells us the price a monopoly firm would receive for every quantity it wishes to sell.
why is average revenue completely elastic in perfect competition
- The firm takes the price from the market, as it can have no influence on the price.
- They are such a small part of the market that they can sell an unlimited amount at the market price without influencing the market price.
- They therefore have a perfectly elastic demand curve.
Why is the level of profit maximisation at MC=MR?
If the firm increases output beyond Q, any additional output is contributing more towards total cost than it is towards total revenue, meaning that profits will be lower, as (MC>MR)
If the firm opts for a lower output below Q, additional units of output could be produced which add more to total revenue than they do to total cost, meaning that current profits are also lower than maximum profit. I.e., continuing to add units of output will continue to increase the distance between TR and TC, so long as MR is above MC.
define MC and MR
Marginal Cost – the extra cost of producing one more unit of output
Marginal Revenue – the extra revenue of producing one more unit of output
define economies of scale
As output increases, and the scale of production therefore also increases, there is a fall in the average costs that the firm faces
What are the different types of economies of scale
- technical economies of scale
- managerial economies of scale
- purchasing economies of scale
- financial economies of scale
- risk-bearing economies of scale
technical economies of scale, definition and examples
- when firms increase their scale of production, they can invest in capital equipment and technology, which may have high fixed costs, but are more efficient than previous machinery, as they incur a lower cost per unit of output in the long run due to their superior efficiency
- smaller firms aren’t capable of making the same investment in newer and specialist machinery due to the limiting factors of being a smaller firm - they may have less space, lower output and profits, therefore the cost of buying the machinery would outweigh the profits that could be made
- for instance, large supermarket chains such as Tesco’s can invest in specialised technology which improves stock control
- or, e.g., expensive specialised machinery which speeds up the process of building a car
managerial economies of scale
- as a firm gets bigger and increases its scale of production, workers are able to divide what was a complex production process into more manageable tasks - workers can specialise in these different tasks, which enables the firm to produce more output at the same time
- whereas when the firm was smaller, workers had to work on all areas of the production process, which not only slowed the process down, but perhaps also prevented them from becoming particularly skilled in one area, now that the firm is bigger and has more workers, each worker can specialise, thus boosting productivity
purchasing economies of scale
- as a firm gets bigger, they have the technology to predict future demand, and the spare capacity to store and use a greater quantity of resources
- therefore, they can bulk buy the resources that they need. Large quantities of the same resource generally means that there are lower unit costs of the raw material used in the production process, because the firm can get a lower unit cost from the supplier when buying more of the good.
- car company bulk buying raw materials such as steel and aluminium for its production process
financial economies of scale
Larger companies are generally deemed more credit-worthy, and therefore have greater access to credit, and lower borrowing costs. In contrast, smaller firms will face higher interest rates on their loans, and won’t be able to take out as much money for a capital investment
risk-bearing economies of scale
- bigger firms are more able to spread their risk, meaning they have improved chances of surviving an economic downturn
what is the difference between internal and external economies of scale, and give examples
external economies of scale depends on external factors, while internal economies of scale depends on internal factors.
- for instance, external EOS, includes any external factor which lowers the firms long run average costs. A group of universities offering highly skilled workers could lower the long run cost for all firms in the area
- internal EOS on the other hand are controlled by the company
what is the minimum efficient scale
- earliest output at which the firm achieves it minium LRAC - smallest level of output for which all economies of scale have been taken advantage of but diseconomies of scale haven’t yet set in
what are increasing returns, constant returns, and decreasing returns to scale
Increasing returns to scale
- when input increasesby a certain amount, output increases by more
Constant RTS
- when input increases by a certain amount, output increases by that same amount
Decreasing RTS
- when input increases by a certain amount, output inceases by less than this amount
what is an external EOS, and give examples
- when a firm achieves lower average costs due to external factors
- skilled labour pool
- govt subsidies
- tax reduction
- improved transportation network
what is an internal EOS, and give examples
- when a firm achieves lower LR average costs brought about by internal factors
Internal factors
- controlled by the company
- any time the company cuts costs, invests in better capital machinery, hires specialised workers
Define diseconomies of scale
- as the firms scale of production gets bigger, its average costs rise
what are the different types of diseconomy of scale
- communication diseconomies of scale
- managerial diseconomies of scale
- coordination and monitoring difficulties
communication diseconomies of scale
- more difficult to send messages across quickly, the bigger the firm
managerial diseconomies of scale
- as the firm gets bigger, works become alienated from the key aims of the firm, resulting in a loss of motivation and efficiency
coordination and monitoring difficulties
- difficult to monitor everyone’s work in a big firm
- loss of organisation is possible
what is the difference between returns to scale and economies of scale
Returns to scale refers to changes in the levels of output as inputs change, and economies of scale refers to changes in the costs per units as the number of units are increased.
