Micro Unit 1- Cost, Revenue And Profit Flashcards
What is the formula for profit?
Profit= revenue-total cost
What is the formula for revenue?
Revenue= price x quantity
What is the formula for total cost?
Total cost= fixed cost + variable cost
What are fixed costs?
What are variable costs?
Fixed costs are costs that do not change based on output, they stay constant e.g. Rent, bank loans
Variable costs are changes in direct correlation with output e.g. raw materials, wages
How do firms maximise profit?
By making sure revenue and total cost is monitored- a business must find the point at which resources are optimised and maximised by finding their point of marginal diminishing returns.
What are variable factors of production in the short run?
What are fixed factors of production in the short run?
Variable factors of production are the factors which can easily vary in size/quantity e.g. farm workers (hire more) or fertiliser (buy more)
Fixed factors of production are factors that cannot easily vary in size/quantity e.g. size of filed, machines (expensive to replace)
What is the short run for factors of production?
The short run is the period of time within which at least one factor of production (CELL) is fixed in size or quantity. Does not or cannot change easily or quickly
What does the law of diminishing returns state?
In the short run when one factor is fixed e.g. capital, if the variable factor is increased e.g. labour there comes a point where they will become less productive and output starts to increase at a diminishing rate. Eventually output will decrease. This law only applies in the short run because in the long run all factors are variable.
Product curves:
Define total product (TP)
Same as total output. This is the totally output produced by workers
Define marginal product (MP)
This is the additional output produced by adding one extra worker in the short run. Difference between the total output and the previous total output.
Define average product (AP)
What is the formula?
Measures output per workers-employed.
Total output/total employees
When does diminishing returns occur for product curves?
Diminishing returns occurs when marginal products starts to fall. This means that total out would be increasing at a decreasing rate.
What does the diagram look like for fixed, variable and total costs?
Look at notes
- Why are fixed costs always a straight line horizontal?
- Explain why variable costs start at zero and slope diagonally upwards?
- Explain why total costs start at the fixed costs point and slope up diagonally on the same gradient as variable costs?
- No matter the quantity demanded, in the short run the cost does not change
- Variable costs start at zero because as the quantity demanded increases, the financial costs becomes more expensive
- Total costs start at the same point as fixed costs as no matter the quantity the cost can never be less than this and then slopes up with the same gradient as variable costs.
What does the diagram look like for average fixed costs (AFC), Average total costs (ATC) and Average variable costs (AVC)?
Look at notes
How are average fixed costs (AFC) calculated?
Average fixed costs= total fixed costs/output
Define average total costs (ATC)
What is the formula?
Also called average cost of unit. Average total costs include how efficiently scarce resources are being used.
Average variable costs= total variable costs/output
Explain the shape of the Average variable costs curve?
It is u shaped and will at first slope downward as from left to right then reach a minimum point and then rise again due to diminishing returns.
Explain the shape of the average total cost curve?
It is also u shaped
Define optimum factors combination?
The combination of factors with which a firm can produce a specific quantity of output at the lowest possible cost.
- Explain why ATC is always above AVC and AFC?
2. Explain why AFC does not have an upwards turn/U shape like the other two?
- ATC is always at the top because it is the combination of both AVC and AFC.
- AFC does not have an upwards turn because there is no diminishing return
Define marginal costs?
Formula?
The additional change in total cost when another unit is produced. It is the addition to total cost from one extra unit produced.
Marginal costs= change in total cost/change in quantity
What does the marginal costs and average cost diagram look like?
What shape is the marginal cost?
What shape is the short run average cost?
Look at notes
Marginal cost- tick shape
Short run average cost- u shape
Why does the MC curve always intersect the AC curve at its lowest point?
Because the marginal cost of making the next unit of output will always affect the average total cost.
When MCAC both costs increasing so is less cost efficient
Why may the AC and MC curves shift?
- An increase in the price of a factor of production
- The profit maximising output is higher, price falls and profit rise
What are some factors that cause only the AC curve to shift?
- Subsidies- lump sum subsidy
- Taxes- lump sum tax
- Rent on retail space
- Interest on bank loans
Fixed costs
Why is the marginal costs curve significant in the theory is the firm?
- It is the leading cost curve because changes in total and average costs are derived from changes in marginal cost
- The lowest price a firm is prepared to supply at is the price that just covers marginal cost.
What affect does a change in fixed costs have on variable costs, marginal costs and average total costs
Variable costs and marginal costs will not change
Average total costs will change because ATC=AVC+AFC
What affect does an increase in variable costs have to MC, AC and AVC?
MC, AC and AVC will shift upwards
What are some examples of how the cost curves will be affected and shift MC, AC, and AVC?
- Lower unit costs for raw materials
- Higher productivity of employees
- Advances in production technologies
- The entry of new producers into the market
- A face in the exchange rate- WIDEC- raw materials more expensive- costs will shift upwards
- Higher unit costs supply e.g. rise in wage rates
- Favourable weather conditions- more output- shift costs down
- Rise in indirect taxes e.g. VAT- less disposable income- less sales
Give an example of something that will just shift ATC?
Increase in amount of government subsidies received- increase production- more investment- expansion- decrease in ATC (spreading costs)
If there is an increase in the price of any factor of production (CELL) what does this affect?
This increases costs and shifts the cost curves upwards to a higher cost level.
If there was an increase in fixed costs what does this affect?
Any increase in fixed costs does not affect the variable cost or marginal cost.
What does the law of demand state?
There is an inverse relationship between price and quantity demanded. As price increases, demand will decrease and vice versa. This is due to a persons income and substitutability factors- alternatives- how elastic is it?
What is average revenue?
What is the calculation for average revenue?
REMEMBER the AR curve is the same as the demand curve
Average revenue is the price per unit
Total revenue/output
What is marginal revenue?
Formula for marginal revenue?
Marginal revenue is the increase in revenue from the sale of one additional unit of output
Marginal revenue= change in total revenue/change in quantity demanded
What does the diagram look like for revenue?
Look at notes
Why does AR fall, slope downwards?
Why does MR go below zero?
AR is falling as more units are sold as the revenue is divided by a greater output. This means the AR curve is downwards sloping.
ME will decline and eventually become negative as eventually no additional revenue is gained form more output. MR curve is always below and steeper than the AD curve- MR falls at twice the rate
Where is the revenue maximisation point on a graph?
Look at notes
Where MR=0, total revenue is maximised
The point where MR=0 is directly underneath the midpoint of a demand curves when the price elasticity of demand=1
Where is the elastic and inelastic section of the AR/D curve?
Elastic- at the top of the demand curve
Inelastic- at the bottom of the demand curve
How do you figure out unit elasticity?
Unit elastic= % chnage in demand=% change in price
What does the diagram look like for total revenue, marginal revenue and average revenue?
Look at notes
Explains the shape of total revenue?
Increases with output to a certain point as customers buy more at lower prices. Total revenue then falls as price falls too far that less money is made
What are the 3 business aims?
- Revenue maximisation
- Sales maximisation
- Profit maximisation
What is revenue maximisation?
What does the diagram look like?
Where is revenue maximisation?
The price to sell to maximise revenue income (no consideration of costs)
Look at notes
Revenue maximisation is at MC=MR
What is sales maximisation?
What does the diagram look like?
Where is sales maximisation?
Sales max is when the firm sells as much as possible without making a loss- costs and revenue considered.
Look at notes
It is were average revenue and average costs intersect AC=AR
Sales maximisation:
Where will firms make a loss?
Where are sales not maximised?
To the right of output the firm will make a loss as costs are increasing and revenue is decreasing
To the left of output sales are not maximised- more sales could be made to earn more money.
What kind of companies are likely to operate at sales maximisation?
- Not-for-profit-organisations as they are not aiming for a profit but want to increase as much revenue as possible.
- Also profit making firms faced with high competition may use this lower price as a way of predatory pricing to drive rivals out of the market- so long as costs are covered, they can afford to do this for a short while. E.g. Amazon where they exploit their monopoly power.
What is profit maximisation?
What does the diagram look like?
Where is profit maximisation
The cost of producing one more unit is exactly equal to the additional revenue gained from selling one extra unit.
Look at notes
The profit maximising point is where MC=MR. This is where marginal profit is 0
Profit maximisation
Where is the supernormal profit on the diagram?
Look at notes
Between C1 and P1
C1- MR=MC
P1- MC= MR up to AR
Define normal profit
Normal profit is when a business is making just enough profit to cover costs and keep operating. Normal profit reflects the opportunity cost of using funds to continue in a business rather than the foregone alternative. If the firm covers its AC then it is making normal profit.
(Break even point)
Where is normal profit on a diagram?
Look at notes
What is abnormal profit?
Profit achieved in excess of normal profit. Not all firms can do this. Any price higher than the normal profit level. Firms making abnormal profits inadvertently attract rival firms to enter a market to get some of this profit.
What does the abnormal profit diagram look like?
Look at notes
What are consequences of setting supernormal profit price in the short run?
- Demand decreases
2. Less consumer confidence
Pros of supernormal profit
Firms can use profit to invest in research and development
Signal that firms are successful and producing products that firms want.
Governments can collect corporation tax from the share of profit.
Enables firms to build up reserves to survive economic downturn
Possibility of supernormal profit is an incentive for entrepreneurs to enter new markets.
