Determining How Much to Sell Flashcards
What is the difference between total revenue, total cost and profit?
Total Revenue = Firm’s return from sale of output
Total Cost = amount paid for inputs used to make output
Profit = total revenue less total cost
How can businesses increase total revenue?
Total Revenue = Price * Quantity Sold
Firms don’t control the price – that is determined by forces of supply and demand
Instead, firms control the quantity they produce & thus the quantity they sell
In order to increase total revenue, firms need to increase the quantity that they sell
The only way to do this is to lower prices
At high prices and low levels of output, demand is likely to be elastic
If prices are falling from a high level, demand is likely to increase by proportionally more, which is going to increase total revenue
However, when prices pass a certain point, demand becomes more inelastic, meaning demand will increase by proportionally less than the price change, resulting in a decrease in total revenue
How does total revenue relate to marginal revenue?
To maximise profitability, a business must also consider the costs of production alongside the total revenue
This is represented as the biggest difference between the total cost curve and the total revenue curve
This point is where the slope of the total revenue curve is tangent to the total cost curve
As long as the revenue of producing another unit of output (MR) is greater than the cost of producing that unit of output (MC), the firm will increase its profit by using more variable input to produce more output
What is the relationship between total & marginal costs/revenue?
This is because the slope of the Total Cost Curve is equivalent to the Marginal Cost
Likewise, the slope of the Total Revenue Curve is equivalent to Marginal Revenue
Therefore, the point where MC and MR are equal is where profit is maximised
How does the seller’s supply curve relate to marginal cost?
A profit maximising firm will take the price and set it equal to the marginal cost
Therefore, the marginal cost is equal to the supply curve
This explains why the supply curve shifts when it becomes cheaper/more expensive to produce products
What will influence the firm’s short-term decision to shut down?
Shutting Down means that production is zero, although a firm still has its assets
Sunk costs are costs that have already been committed and cannot be recovered
- These are the fixed costs of production
To continue producing in the short run, a firm needs to at least cover its variable costs
Therefore, if the price is less than the average variable price of production, than a firm should shut down
Graph the decision making process of a short-term decision to shut down
At the points on the marginal cost curve that are below the average variable cost, the price is going to be less than the average variable cost
In that case, the best option is for the business to shut down
The red line represents where the firm should continue producing
What will influence the firm’s long-run decision to shut down?
Given some costs are fixed in the short run yet variable in the long-run, a firm’s long-run cost curves differ from its short-run cost curves
Now the decision becomes whether to produce or exit the industry completely
To continue producing in the long run, a firm needs to be making a profit
Therefore, if the price is less than the average total cost of production, a firm should exit the market
Graph the decision making process of a long-run decision to shut down
Graph how a business can maximise profits
Graph how a business can be making negative profits
Graph the point where business profits are zero
Why should a business seek economies of scale?
When a company is producing a good, it is best to be at the bottom of the ATC curve
This is because the effect of high fixed prices has been mitigated, while variable costs are not influential enough to increase average price
In short, the cost of producing the product has been minimised
How can a business achieve long-run economies of scale?
When a business is doing so well that its average total costs are rising, it should expand capacity
This involves buying more fixed inputs that have a greater capacity for production
This will create a new cost structure where the average total cost is lower at a greater quantity of production
Over time, this will create a Long Run Average Cost Curve, of which the business should aim to operate at the lowest level
