Microeconomics: Production costs and Revenues

Question 1

What is division of labour?

Answer 1

Occurs when the production process is broken down into many separate tasks.
Can raise productivity as people become proficient through constant repetition of a task (learning by doing)

Question 2

What is an example of division of labour?

Answer 2

Vehicle manufacturing - Each worker on an assembly line has a specialised task such installing a specific component or performing a particular operation.

Question 3

What are the potential advantages of division of labour?

Answer 3

Higher productivity
Leads to higher output per person/per hour worked which improved productivity
Increased efficiency in production
Economies of scale (firms grows larger so that the average costs fall)

Question 4

What are the potential disadvantages of division of labour?

Answer 4

Risks of repetitive strain injury at work - impact the economy due to health services being pressured as well as firms as there is one less worker.
Reduced job satisfaction due to boredom can hamper labour productivity and causes increased workplace absenteeism.
Some workers receive little training and may struggle to find alternative jobs when out of work.
lack of quality - bad for firms

Question 5

What is specialisation?

Answer 5

Process by which individuals, firms, or regions concentrate their efforts on producing a narrow range of goods/services in which they have a comparative advantage.

Question 6

What are the advantages of specialisation?

Answer 6

Higher labour productivity and rising business profits
Specialisation creates a surplus output that can be traded for mutual benefit.
Lower prices cause higher real incomes and GDP growth.

Question 7

What are the benefits of specialisation on workers?

Answer 7

More motivation and job satisfaction because they are good at what they do.
Workers skills will be improved
Specialised workers get higher pay because they are better at it than others which increases productivity.
HOWEVER, IT DEPENDS ON THE NATURE OF THE WORK THEY ARE DOING

Question 8

What are the costs of specialisation on workers?

Answer 8

Workers may be replaced by machinery
Workers skills may suffer as they are only doing one job
Boredom- this can be overcome by having a nice working area

Question 9

What are the benefits of specialisation on firms?

Answer 9

High productivity
Increased productivity lowers average costs
Higher quality
HOWEVER, IT DEPENDS ON HOW SPECIALISED THEY ARE- THE EXTENT TO WHICH THEY SPECIALISE

Question 10

What are the costs of specialisation on firms?

Answer 10

More expensive workers
Quality may suffer if workers are bored
Greater cost of training

Question 11

What are the benefits of specialisation on regions?

Answer 11

Job creation and improved standard of living
Infrastructure development
Efficient use of resources as using resources wisely causes less waste

Question 12

What are the costs of specialisation on regions?

Answer 12

Loss of advantage (if another region becomes better at producing it)
Risk of fall in demand (if demand falls, people will be out of a job e.g. Saudi Arabia specialise in oil)
Resource exhaustion (It depends on how prepared they are)

Question 13

What are the benefits of specialisation on countries?

Answer 13

Job creation and improved standard of living
Increased international trade as there are more products to trade
Greater efficiency = greater output = government revenue

Question 14

What are the costs of specialisation on countries?

Answer 14

Unemployment
Risk of over-specialisation (over-dependence)
Negative externalities

Question 15

What does production measure?

Answer 15

volume/value of output in a given time period.

Question 16

What does productivity measure?

Answer 16

Efficiency of factors of production in a given time period.

Question 17

What is the difference between short-run and long-run production?

Answer 17

Short-run production is when at least one factor of production (usually capital) remains fixed, while others can be varied. Long-run production is when all the factors of productions are variable, and the scale/capacity of production can change allowing a business to potential benefit from internal economies of scale.

Question 18

What is the law of diminishing returns?

Answer 18

As more units of a variable input are added to a fixed output, after a certain point, the marginal product of the variable input will begin to decrease.

Question 19

What is the law of diminishing returns in short-run?

Answer 19

As number of workers increase, productivity decreases. As a result total output still increases but marginal product and average product decreases.

Question 20

What happens when diminishing returns sets in?

Answer 20

The marginal product of the labour starts to fall and the marginal cost of supply will increase because in order to produce more output, the producer needs to add more of the variable input, which becomes less productive as more of it is added.

Question 21

What are fixed costs?

Answer 21

Costs that do not vary with output so remains constant regardless of whether the business produced a high or low quantity of goods/services.
e.g. salaries, rent, loan repayments
the higher the level of fixed costs in a business, the higher must be the output for a firm to break-even.

Question 22

What are variable costs?

Answer 22

Costs that change directly with output so it increases as production or sales increase.
In the short-run, variable costs will rise when production expands.
e.g. energy costs, wages, raw materials, commission bonus

Question 23

How can average variable cost be calculated?

Answer 23

Total variable costs (TVC) / Output (Q)

Question 24

How can average fixed cost be calculated?

Answer 24

Total fixed cost (TFC) / Output (Q)

Question 25

What happens when production increases in the short-run?

Answer 25

Total fixed costs remains the same therefore, average fixed cost (AFC) must fall.
This important for start-up and challenger businesses because if they can ramp up sales and output quickly, then they can bring down AFC and lower their ATC to make them more cost and price competitive.

Question 26

How is total cost calculated (TC)?

Answer 26

TFC + TVC

Question 27

How is average cost calculated?

Answer 27

TC / Q

Question 28

How is marginal cost calculated (MC)?

Answer 28

Change in total cost / Change in output

Question 29

What is the average and marginal cost diagram?

Answer 29

MC intersects AC at its lowest point.
AC= “U” shape due to economies of scale than diseconomies of scale.
Initially due to the law of increasing marginal returns, the MC curve dips.
However, due to the constraints of a fixed factors input (land) additional inputs produce a less than proportional amount of output (decreasing marginal returns) the cost of.

Question 30

What is the law of increasing marginal returns?

Answer 30

Extra unit input produces a more than proportional amount of output.

Question 31

What happens when marginal costs are less than average costs?

Answer 31

Average costs fall

Question 32

What happens when marginal costs are greater than average costs?

Answer 32

Average costs rise

Question 33

What are economies of scale?

Answer 33

The most advantage a firm can gain by increasing the scale of production leading to a fall in average costs.

Question 34

What are the internal economies of scale?

Answer 34

Purchasing: larger firms (able to produce more) can buy in bulk and therefore receive a discount (convenience for firms-guaranteed sales) lowering AC.
Financial: Larger firms are offered lower interest (more reliable, trustworthy, less risky) as they borrowing a larger amount (banks will get a larger return) therefore lowering AC.
Risk bearing: Large firms can diversify and spread their costs so if one area fails, they can still survive.
Managerial: Larger companies need and can afford specialised managers who thereby increase productivity which decreases AC.
Technical: Larger firms can afford better technology which helps improve efficiency/productivity and lower AC.
Economies of increased dimensions: Companies can spend less on packaging/ shipping if customers buy in bulk, reducing AC.
Division of labour: As firms get larger, they can distribute tasks t specialised workers, who are more productive, and therefore AC falls.
Research and development: Research costs can spread across the business decreasing AC.
Marketing: AC of advertising falls as the firm will only pay for one advert but is spread across many products/stores.

Question 35

What are the external economies of scale?

Answer 35

Transport infrastructure: Better roads, faster rail travel (HS2 more terminals at airports, etc)
Research and development infrastructure: A local university’s R and D facilities can overcome the problem of small firms being unable to afford their own.
Location: (e.g. Canary Wharf- banks) Don’t have to search for workers as a lot of people will already be at the location.
Concentration of firms: Suppliers of parts may locate near the main producer, thus cutting transport taxes. e.g. Nissan has a factory in Sunderland with their own suppliers on-site as well as more in the immediate area.

Question 36

What is diseconomies of scale?

Answer 36

When a firm grows beyond a certain size causing average costs to increase.

Question 37

What are examples of diseconomies of scale?

Answer 37

Loss of control: As a firm gets too big it becomes very difficult to monitor the productivity of individual workers and so efficiency may suffer.
Lack of coordination: As a firm becomes too big it becomes very difficult to co-ordinate production, especially across different sites, regions, and countries. e.g. NHS
Lack of cooperation: As a firm grows bigger, workers can feel alienated and undervalued which can lower motivation.

Question 38

What is revenue?

Answer 38

Money income a firm receives from selling its output.

Question 39

What is total revenue (TR)?

Answer 39

All the money a firm earns from selling the total output of a product.
-selling one more unit of a product will cause total revenue to rise

Question 40

How is average revenue calculated?

Answer 40

TR/Q

Question 41

How is marginal revenue calculated?

Answer 41

Change in TR/Change in Q

Question 42

What do the revenue curves (at the firm level) in a perfectly competitive market show?

Answer 42

Monopoly-1 firm in a market
Barriers to entry: costs, qualifications, legal requirements
A perfectly competitive market generates a perfectly elastic demand curve.

Question 43

What does the perfectly elastic demand curve show?

Answer 43

No sales if the firm tries to charge a higher price customers will go to competitive.
No sales- setting a price lower than the ruling market price. Price will reduce profits and not extra sales.

Question 44

What do the revenue curves in an imperfectly competitive market show?

Answer 44

Normal downward sloping demand curve- a firm has to drop the price if they want to sell more.

Question 45

What does the total revenue curve show?

Answer 45

TR increases as a firm drops its price.
The firm has lowered its price too much as TR decreases.

Question 46

What is profit?

Answer 46

Difference between the total revenue of a firm and its total costs.

Question 47

How is profit calculated?

Answer 47

TP=TR-TC

Question 48

How does profit maximisation occur?

Answer 48

Occurs at the level of output at which total profit is greatest (MC=MR)

Question 49

What is the role of profit in a market economy?

Answer 49

Attracts new firms into the market e.g. AI, social media.
The creation of worker incentives: some companies use profit-related pay to increase worker motivation, in the hope staff will work harder& buy into the firm’s objectives e.g. Banks, John Lewis. However, can be counter-productive if other workers see higher management enjoying big bonuses while they receive a smaller wage.
The creation of shareholder incentives: high profit generally leads to high dividends/distributed profit being paid out to shareholders who own companies, which incentivizes people to buy the company’s shares. Therefore, the company’s share price rises, which makes it cheaper and easier for a business to raise finances.
Profits and resource allocation: High profits create incentives for new producers to enter the market and for existing firms to supply more of a good/service. A loss/failure to make abnormal profits creates incentives for firms to leave markets and deploy their resources in more profitable markets.
Profit as a reward for innovation and risk-taking: If entrepreneurs believe that innovation will lead to high profits in the future, the incentive to innovate increases. There are risks involved, but successful risk-taking leads to high profits.
Profit as a source of business finance: Retained profits are arguably the most important source of finance for firms undertaking investment projects as it is available straight away.

Question 50

What is normal profit?

Answer 50

The minimum level of profit necessary to keep firms in the market but is not sufficient to entice other firms into the market.
Reflects the opportunity cost of using funds to finance a business.
Occurs when AR=AC

Question 51

What is supernormal profit?

Answer 51

Profit over and above normal profit.
When firms are making abnormal profits, there is an incentive for other producers to enter a market to try to acquire some of the profit. Abnormal profit persists in the long run in imperfectly competitive markets such as oligopoly and monopoly where firms can successfully block the entry of new firms.

Question 52

What is a monopoly?

Answer 52

One seller in the market e.g. royal mail, water supplier.

Question 53

What is an oligopoly?

Answer 53

A few firms dominate the market e.g. supermarkets (Big 4)
High barriers to entry

Question 54

What are the objectives of firms?

Answer 54

Profit maximisation: If MR>MC, then selling an extra unit will add to profit.
benefits- source of finance (it depends on what stage the business is at, not the only source of finance, it depends on how they profit maximise)
Revenue maximisation: Output level where MR=0
benefits = growing a business- more market share, economies of scale.
Sales growth maximisation (occurs when price per unit=AC)- generating the highest possible level of sales within a given period perhaps as part of a wider objective of growing market share and/or building a brand. As sales increase, a business may be able to take advantage of economies of scale, leading to lower AC. This could enhance the business’s profitability in the long run.
Environmental and social obligations- reducing carbon emission, waste reduction, and recycling e.g. McDonald’s converts oil into fuel. Businesses can engage with local communities through incentives such as funding education programmes- people are more likely to invest or buy from the business.

Question 55

What is the difference between innovation and invention?

Answer 55

invention is the process of creating a new product or a new way to make a product.
Innovation is the act of improving or contributing to existing products.

Question 56

How does technological change result in improvements in efficiency and productivity?

Answer 56

Technological change can result in improvements in efficiency and productivity, which could lower costs of production for firms. The quality and quantity of goods and services produced might improve.
For example, mobile phones have become cheaper to produce, so their price has fallen. More importantly, their quality has improved significantly. This is due to improvements in technology

Question 57

How can technological change affect to the development of new products?

Answer 57

Technological change can lead to the development of new products, and the development of new markets and may destroy existing markets. For example, the development of DVDs, then Blu-rays, and now the rise of downloadable films, has essentially destroyed the market for VHS video tapes.

Question 58

What is creative destruction?

Answer 58

Schumpeter, an economist, proposed the idea of ‘creative destruction’. This is the idea that new entrepreneurs are innovative, which challenges existing firms. The more productive firms then grow, whilst the least productive are forced to leave the
market. This results in an expansion of the economy’s productive potential.

Question 59

How does technological change influence the structure of markets?

Answer 59

Monopolies do not have an incentive to innovate, since they have no competition. This means they are often inefficient and their costs are higher than they could be. Oligopolies tend to have more of an incentive to innovate, since they are earning supernormal profits and are trying to get ahead of their competitors. This means
that technological change is quite fast in oligopolies.