Micro 16 - Profits and losses Flashcards
Define profit
Profit is the difference between revenue and costs and is made when revenue is greater than costs
State the formula for calculating profit
Profit = Revenue - Total costs
What is profit maximisation as an objective for a firm?
Profit maximisation is an objective for some firms and involves making as high a level of profit as possible
When is profit maximisation acheived?
MR=MC
Explain the steps to draw a costs and revenue diagram for all types of profits/losses being made
1- Draw the axis and label them with costs and revenues on the y-axis and quantity of output on the x-axis
2- Draw the AR and MR curve remembering MR is twice as steep as AR
3- Draw the MC curve
4- Find the profit maximising output which is where MR=MC, label this Q1
5- Label the price level of this output level by going up to the AR curve from Q1
6- Draw the AC curve. Where you place this will determine how big a profit or loss your business makes. Wherever it goes it must cross MC at its lowest point
7- At Q1 find the average cost and draw a dotted line across and label this C1
8- At the profit maximising output, look at the vertical difference between P1 and C1. The difference between the two is the profit per unit.
9- To find the total profit, multiply the profit per unit by the number of units. This rectangle represents supernormal profit
10- This process is the same whether you want to show supernormal profit, normal profit or a loss, the only thing that changes is the position of the AC curve
What is the difference between the general idea of costs and economic costs?
Accounting/general costs only include what economists call ‘explicit costs’. These are physical costs of production such as energy costs and wages whereas economic costs include opportunity costs
What are economic costs in terms of a formula?
Economic cost = Money cost + opportunity cost
Define Normal profit
Normal profit is the minimum reward (level of profit) that is just sufficient to keep a firm in a particular industry.
On a diagram, where does normal profit occur?
On a diagram, normal profit occurs when total revenue is equal to total costs
Draw a costs and revenues diagram to show a firm making normal profit
See page 7 in pack 16
Define Supernormal profit
Supernormal profit is profit that is made in excess of normal profit
Draw a costs and revenues diagram to show a firm making supernormal profits
See page 8 in pack 16
Draw a costs and revenues diagram to show a firm making a loss
See page 8 in pack 16
Which curves shift on a costs and revenues diagram if fixed costs change?
- If fixed costs change only AC shifts
- This means the quantity stays the same
If fixed costs increase/decrease which way will the AC curve shift?
- If fixed costs increase AC will shift upwards
- If fixed costs decrease AC will shift downwards
Which curves shift on a costs and revenues diagram if variable costs change?
- If variable costs change then both MC and AC shift
- This will mean a new quantity
If variable costs increase/decrease which way will the AC and MC curves shift?
- If variable costs increase they both shift upwards
- If variable costs decrease they both shift downwards
Which curves shift on a costs and revenues diagram if demand changes?
- If demand changes then MR and AR will shift
- This will mean a new quantity
What is generally the easiest way to draw a costs and revenues diagram involving shifting curves?
Start with a normal profit diagram before shifting curves
When shifting both the MR and AR curves what must you make sure?
When shifting the MR and AR curves you must make sure the shifted curves are parallel to their original curves
Draw a costs and revenues diagram to show a firm revenue maximising
See page 10 in pack 16
What type of profit must a firm make to justify staying in an industry in the long run?
A business needs to make at least normal profit in the long run to justify remaining in an industry, but in the short run a firm will continue to produce as long as total revenue exceeds total variable costs
What is the short run shutdown point?
The short-run shutdown point is when price per unit is equal to average variable cost (AR=AVC)
In the short run should a firm shutdown if AR>AVC?
In the short run, if AR>AVC then each additional unit sold will reduce the size of any losses and contribute to fixed costs. The firm will be better off continuing to operate as they will be reducing the size of their losses
In the short run should a firm shutdown if AVC>AR?
A firm will shutdown when AVC>AR because every additional unit sold will add to losses
Why should a firm continue to operate when its making a loss in the short run?
- In the short run firms cannot change industry - they are stuck in their current industry
- A firm’s fixed costs must be paid regardless of the level of output
- Often these costs cannot be recovered if the firm shuts down (sunk costs), so the loss per unit would be greater if the firm were to shutdown provided variable costs are covered
When will firms shutdown in the long run?
Firms will shutdown in the long run if ATC>AR because every additional unit sold will add to losses. They may then leave the industry and switch their factors of production for use in more profitable markets
How would short run and long run shutdown points be displayed on diagrams?
See page 14 in pack 16
Define the scale of production
The scale of production refers to the number of products made and is determined by the quality and quantity of factors of production used and production techniques implemented
Define the long run average cost (LRAC)
- The long run average cost (LRAC) of a firm shows the lowest average cost at which a firm can produce any given level of output in the long run (when all FOP are variable)
What does the LRAC and SRAC curves on a costs diagram represent?
The LRAC curve is the envelope of the short run average total cost (SRAC) curves. Each SRAC curve shows the average costs in the short run at a specific quantity of capital goods
Draw a LRAC and SRAC diagram
See page 17 in pack 16
What can an LRAC and SRAC diagram be used to show?
It can be used to show both economies and diseconomies of scale
Define Economies of scale
Economies of scale refers to the benefits gained through producing on a larger scale. A fall in long run average costs as output increases
Define Diseconomies of scale
Diseconomies of scale refers to an increase in long run average costs as output increases beyond the point of minimum efficient scale
Define Internal economies of scale
Internal economies of scale arise because of the growth in the scale of production within a firm
What are the different types of internal economies of scale?
- Technical economies of scale
- Purchasing economies of scale
- Managerial economies of scale
- Financial economies of scale
- Marketing economies of scale
- Risk-bearing economies of scale
What are technical economies of scale?
Technical economies of scale are occur when a firm is growing and it invests in expensive and capital machinery which allows the firm to have increased productivity and lower average costs. These lower costs can improve productive efficiency
What are purchasing economies of scale?
Purchasing economies of scale occurs when larger firms are able to buy raw materials and components of production in bulk. Bulk buying enables the firm to secure lower prices for their purchases by gaining discounts which lowers average variable costs
What are managerial economies of scale?
Managerial economies of scale occur when a firm expands and is able to employ specialist workers and managers to split complex production processes into separate tasks to boost productivity, lowering average cost
What are financial economies of scale?
Financial economies of scale occur when a firm grows it is better able to access loans as larger firms are usually rated by the financial markets to be more ‘credit worthy’. These loans are also likely to be granted at a lower interest rate than those to smaller firms as larger firms are considered a lower risk
Why may banks see larger firms as lower risk than smaller firms?
- They have more assets to put up as collateral
- They are more credit worthy
What is marketing economies of scale?
Marketing economies of scale is when as a firm expands its product range it can spread its advertising and marketing budget over a large output. The firm is able to promote and raise product/brand awareness of any additional or new products in one marketing or advertising campaign for little to no additional costs
What are risk-bearing economies of scale?
Risk bearing economies of scale happen when as a firm expands it is better able to develop a range of products and a wider customers base to spread risk and minimise the impact of any downturn
Define Diseconomies of scale
Diseconomies of scale refers to an increase in long run average costs as output increases beyond the point of minimum efficient scale
What are some examples of diseconomies of scale?
- Control - Monitoring the productivity and the quality of output from thousands of employees in big corporations is imperfect and costly
- Co-ordination - It can be difficult to co-ordinate complicated production processes across several plants in different locations and countries
- Co-operation- Workers in large firms may develop a sense of alienation and loss of morale. If they do not consider themselves to be an integral part of the business their productivity may fall leading to wastage of FOP and higher costs
Define the minimum efficient scale (MES)
The minimum efficient scale (MES) is the lowest level of output where long run average cost is minimised
Draw to diagrams showing both a high MES and a low MES
See page 28 in pack 16
Define External economies of scale
External economies of scale happen outside the control of a company and will result in a reduction in costs and increases in productivity of an entire industry
