LS3 - Costs & Revenues

Question 1

Short run

Answer 1

• at least one fixed factor of production
• the period over which the firm is free to vary the input of variable factors but not fixed factors
• capital and land usually fixed
• usually vary labour

Question 2

Long run

Answer 2

• When all factors of production are variable
• can vary capital and labour
• likely firm will choose the level of capital that’s appropriate for output level it expects to produce

Question 3

Law of diminishing returns

Answer 3

• in short run, assuming capital is fixed, if the variable inputs increase then gradually there will be less additional output per unit of labour
• states that in the short run when variable factors of production are added to a stock of fixed factors of production marginal product will rise then fall

Question 4

Fixed costs vs variable costs

Answer 4

• known as sunk costs - can’t avoid paying even if output is 0
• vary with output, for example wages/operating costs

Question 5

total costs

Answer 5

total fixed costs + total variable costs

Question 6

total fixed costs on graph (short run)

Answer 6

horizontal line - does not vary with output

Question 7

total variable costs on graph (short run)

Answer 7

• curve ( like cubic kind of)
• initially increasing returns to labour, as costs (e.g. labour) increases so does output
• at start costs are high as need to initially hire workers
• as gets horizontal output increases without costs doing so too much
• then law of diminishing returns sets in and costs accelerate

Question 8

total costs on graph (short run)

Answer 8

like TVC just starting higher in line with TFC

Question 9

LRAC curve

Answer 9

• join lots of SRAC curves together
• kind of like quadratic with horizontal bottom

Question 10

Average fixed costs (AFC)

Answer 10

AFC = Fixed Costs / Output
- as output increases AFC will continue to fall as fixed cost is being spread over greater output
- on graph negative gradient (not linear)

Question 11

Average variable costs (AVC)

Answer 11

AVC = Variable Costs / Output
- Shaped like quadratic, -ve gradient is when productivity increases as labour does so AVC falls, +ve gradient is due to law of diminishing returns

Question 12

Average Cost/Average total cost (AC/ATC)

Answer 12

AFC + AVC = AC
AC = TC/Q

Question 13

Marginal cost (MC)

Answer 13

• change in total cost when one additional unit of output is produced
• like quadratic but more of the +ve gradient and goes through minimum of AVC & AC

Question 14

relationship between AVC & AC on graph

Answer 14

• same shape with AC above AVC
• gap between is AFC
• but as output rises gap closes and AVC is closer to AC as AFC falls as costs spread out more as output increases

Question 15

Revenue

Answer 15

• payments firms receive when they sell goods/services they produce over a given time period

Question 16

Total Revenue (TR)

Answer 16

TR = P x Q

Question 17

Marginal Revenue (MR)

Answer 17

• additional revenue arising from sale of an additional unit of output
  MR = change TR / change Q

Question 18

Average revenue (AR)

Answer 18

AR = TR / Q
AR = P
as AR = (P x Q) / Q so Q cancels out

Question 19

when firm has no control over price

Answer 19

• Perfect competition with infinite buyers/sellers and identical goods/services - price takers and no barriers to entry/exit
• MR=AR as price stays then same and doesn’t change
• so MR=AR=P and is horizontal as doesn’t change
• so TR is linear, revenue increases by same amount each time output does

Question 20

when firm has control over price

Answer 20

• imperfect competition, few buyers/sellers with differentiated goods/services, price makers and barriers to entry/exit
• price at which good is sold changes as output does
• MR doesn’t equal AR
• AR=D
• AR=D & MR are negative linear lines with MR twice as steep
• TR is negative quadratic shape

Question 21

relationship between PED and AR & MR

Answer 21

• top half of D curve is elastic and bottom is inelastic, same for AR as D=AR
• so then when elastic, if prices fall, then total revenue rises
• so then when inelastic, if prices fall, then total revenue falls