MICRO - costs, revenues and profit ✅ Flashcards
what are the types of production
Short run production – at least one fixed factor input (usually capital eg machinery/technology) in short run business output expands when more variable factors brought into use
Long run production – all of the factors of production can change (variable) allowing business to change scale of operations
LENGTH OF TIME BETWEEN SHORT/LONG RUN VARIES IN INDUSTRIES
what is productivity
- Measure of efficiency by output per person employed
- Better measure of productivity is total factor productivity, taking into account the changes in amount of capital and labour force
- more productive = lower average costs per unit of output
what does higher productivity lead to (4)
- Improved competitiveness and trade performance = reduced international prices
- Higher profits = can be reinvested into long term growth
- Higher wages = when linked with marginal revenue productivity theory, productivity is rewarded with higher wages
- Economic growth = increase in trend rate
what is the law of diminishing returns
- occurs in the short run
- The variable factor could be increased in the short run (eg. firms might employ more labour)
- Over time, labour will become less productive, so marginal return of the labour falls and an extra unit of labour adds less to the total output than the unit of labour before
- Therefore, total output still rises, but it increases at a slower rate linking to productivity
what does the law of diminishing returns assume
Law assumes firms have fixed factor resources in the short run and that the state of technology remains constant
However, the rise of out-sourcing means that firms can cut their costs and their production can be flexible
what is the difference between total, marginal and average product
TOTAL PRODUCT (returns) = total output/units produced
MARGINAL PRODUCT = additional output produced when extra worker (or factor of prod.) employed
AVERAGE PRODUCT = total output / number of workers (productivity)
when marginal product of extra labour falls marginal cost of supplying extra output increase
what are returns to scale
refers to change in output of a firm after increase in factor inputs
what are increasing returns to scale
when output increases by greater proportion to increase in inputs
when % change in output > % change in inputs
what are decreasing returns to scale
when % change in output < % change in inputs
output increases by smaller proportion to increase in inputs
linked to diseconomies of scale, occurs when firms become less productive
what are constant returns to scale
when output increases by same amount that input increases by
% change in outputs = % change in inputs
what is the difference between fixed and variable costs
- fixed costs dont vary with output eg rents, advertising. theyre indirect
- variable costs change with output, direct costs. eg raw materials cost. Q increase = TVC increase
what is the difference between average variable costs, total costs, average costs and marginal costs
average variable costs (AVC) = total variable cost / output
total costs = total variable costs + total fixed cost
average costs = total costs / quantity produced
marginal cost of production is the cost of producing one extra unit of output
what shape is the average total costs curve
ATC curve = U shaped due to diminishing returns because factors are fixed
at one point, employing more resources is less productive = marginal output decreases per extra factor of production and marginal costs increase
what is the shape of the long run cost curve
- initially average costs fall = economies of scale = falling average costs as output increases
- after optimum level of output, point of lowest average costs, the average costs rise due to diseconomies of scale
in long run, all factors of production assumed to be variable = scale of production can change
how do factor prices and productivity affect a firm’s costs of production and choice of factor inputs
- if factor inputs more productive, firms can produce more output with a smaller input. This results in lower unit costs of production.
- As the average cost per unit of one factor input rises, such as labour, firms are likely to switch to cheaper (and generally more productive) factor inputs, such as capital
what is the shape of the AVC curve
average variable cost (AVC) is variable cost per unit of output
shape of AVC determined by shape of marginal cost, rising MC due to diminishing returns
average fixed costs fall continuously as output increases because total fixed costs spread over higher level of production
AFC difference between AC and AVC
what is the impact of increased fixed costs
increased fixed costs = upward shift in ATC doesn’t cause marginal cost curve to change
changes in fixed costs only causes AC curve to shift not MC but variable costs changes shift both
what is an internal economy of scale
- occur when firm becomes larger
- average costs of production fall as output increases
what is the mnemonic for internal economies of scales examples
Really Fun Mums Try Making Pies
RISK-BEARING: larger firms can expand production range, uncertainty costs spread
FINANCIAL: banks willing to lend loans cheaper to large firms, less risk
MANAGERIAL: larger firms able to employ specialist managers and supervisors, lowering average costs
TECHNOLOGICAL: larger firms can invest in productive machinery and capital, lowering average costs
MARKETING: larger firms divide marketing budgets so average cost of ad per unit is less
PURCHASING: larger firms can bulk-buy, each unit will cost less if it has monopsony power
NETWORK ECONOMIES OF SCALE: gained from expansion of ecommerce, large online shops can add extra goods/customers at low cost
what are examples of technical economies of scale
EXPENSIVE (indivisible) capital inputs: large scale businesses affording investment in specialist capital machinery
SPECIALISATION OF THE WORKFORCE: larger firms splitting production processes into different tasks to boost productivity
LAW OF INCREASED DIMENSIONS (container principle) : linked to cubic law where doubling height and width leads to a more than proportion increase in cubic capacity
LEARNING BY DOING: average production costs declining as production experience means businesses cut waste and find most productive way of producing output on bigger scale
what are external economies of scale
occur within the industry, lowering many unit costs
entire LRAC curve will shift DOWNWARDS
eg local road improvements = reduced costs for local industries
what are diseconomies of scale
occur when output passes a certain point (decreasing returns to scale) and average costs start to increase per extra unit of output produced
why do diseconomies of scale occur
Control: It becomes harder to monitor how productive the workforce is, as the firm becomes larger
Coordination: It is harder and complicated to coordinate every worker
Communication: Workers may start to feel alienated as the firm grows. could lead to falls in productivity and increases in average costs, they lose their motivation
what are the effects of diseconomies of scale
- business moved beyond optimum size
- productive inefficiency suffered
- highly skilled workers may leave
- lower worker morale = lower productivity = increased unit costs = reduction of total profits = possible raised prices to cover costs
- declining market share if competitiveness lost
- rise in firms long run average cost of production
what is the minimum efficient scale (MES)
- scale of output where internal economies of scale fully exploited
- MES = lowest level of output where it’s the lowest point on a firm’s long run average cost curve (LRAC) reached
how does competition affect minimum efficient scale
- likely to be low relative to size, in competition there is more room for businesses to compete
- MES high in natural monopoly (industry highly concentrated)
- if LRAC same as output increases = constant returns to scale
causes of businesses having a high minimum efficient scale
- MES high when fixed costs are large
- MES high when marginal cost of supplying to extra customers is low relative to fixed costs eg digital business cost of adding extra customer to network is low (network economies of scale)
- Natural monopoly = long run average cost falls across range of output = MES is high % of total market demand, room for only one firm to fully exploit economies of scale
examples of markets with high/low MES
high:
- water/gas/electricity supply
- underground transport systems
- social networks and search engines
low:
- cafes/coffee shops in large city
- hotels
- dry cleaners
why does LRAC fall
- some firms need high output to benefit from economies of scale and have falling LRAC
- typical of firms providing ‘network’ eg national grid/rail, known for natural monopolies
- for these firms, LRAC are always falling and rarely reach minimum efficient scale of output
explain the shape of the LRAC curve
- LRAC curve envelopes the SRAC curve, and it is always equal to or below the SRAC curve
- the LRAC curve shifts when there are external economies of scale, i.e. when an industry grows
- SRAC falls at first, and then rises, due to diminishing returns. In the long run, costs change due to economies and diseconomies of scale
what happens at SRAC = LRAC
firm operates where it can vary all factor inputs
why is the curve L-shaped
- L-shape curve is a development in cost theory from the traditional U-shaped curve. suggests that to begin with, costs per unit fall as output increases, due to economies of scale
- even if there are diseconomies of scale within the firm, eg managerial costs increase, they are offset by the economies of scale gained by technical or production factors
- means in long run, costs continue to fall, even if the pace of falling output costs slows (shown by the flat part of the curve)
what is the difference between marginal, average and total revenue
AVERAGE REVENUE (AR) = price per unit = total revenue / output (demand curve)
MARGINAL REVENUE (MR) = change in revenue from selling one extra unit of output
TOTAL REVENUE (TR) = price per unit X quantity OR AR x Q
what is the shape of the AR curve
- AR curve is the demand curve because the average revenue curve is the price of the good
- in markets where firms are PRICE TAKERS the AR curve is horizontal, showing the perfectly elastic demand for their goods
- profit is difference between TR and total costs
when is revenue maximised
maximum total revenue occurs where marginal revenue = 0 (no more added revnue can be achieved from producing and then selling extra unit of output)
how does elasticity relate to revenue maximisation
- where MR = 0 is directly underneath the mid-point of a linear demand curve and co-efficient of PED = 1
- PED is unitary when TR is maximised
- when marginal revenue turns negative (if prices cut) then TR would fall
what happens to elasticity when marginal revenue is positive/negative
MR positive = relatively elastic PED (fall in price smaller than increase in QD)
MR negative = relatively inelastic (fall in price larger than increase in QD)
what happens when demand is perfectly elastic
When demand is PERFECTLY ELASTIC, marginal revenue = average revenue
what is marginal revenue
- marginal revenue measures the change in total revenue with respect to changes in the amount of goods and services sold
- marginal revenue is calculated by the change in total revenue divided by the change in quantity sold
what are price takers
- operate in perfectly (highly) competitive markets
- no pricing power, accept prevailing market price
- perfectly elastic demand curve
- AR identical to MR, every unit sold at exact same price
- low % market share
- TR simply upwards sloping line
what are price makers
- have the ability/power to set their own prices
- imperfectly competitive markets
- demand curve (AR) curve DOWNWARD SLOPING
- marginal revenue (MR) lies below AR
how does PED change along demand curve
- high prices = fall in price and elastic price response
- demand is price elastic towards bottom of demand curve (fall in price = drop in TR)
what is normal profit
- the minimum reward required to keep entrepreneurs supplying their enterprise
- it covers the opportunity cost of investing funds into the firm and not elsewhere
- this is when total revenue = total costs (TR = TC)
- normal profit is considered to be a cost, so it is included in the costs of production
- AR = AC (zero economic profit)
what is supernormal (abnormal) profit
- the profit above normal profit
- this exceeds the value of opportunity cost of investing funds into the firm
- when TR > TC
- incentives for other producers to enter market
- AR > AC
what is subnormal profit
- profit less than normal (price per unit < average cost)
- economic loss
- AC > AR
what can profit help to do
- finance capital investment and research
- market entry, sends signals to other producers within market
- demand for and flow of factor resources
- signals about health of economy, rising profits reflect supply side performance improvement
