Production, Costs and Revenue Flashcards
What does production do
Converts inputs, or the services of factors of production, into final output
Productivity
A measure of efficiency that calculates the amount of outputs produced per unit of input
Labour productivity
Output per worker
Benefits of specialisation and division of labour
- Higher output and potentially higher quality, since production focusses on
what people and businesses are best at. - There could be a greater variety of goods and services produced.
- There are more opportunities for economies of scale, so the size of the
market increases. - There is more competition and this gives an incentive for firms to lower their
costs, which helps to keep prices down.
Disadvantages of specialisation and division of labour
- Less developed countries might use up their non-renewable resources too
quickly, so they might run out. - Countries could become over-dependent on the export of one commodity,
such as wheat. If there are poor weather conditions, or the price falls, then
the economy would suffer.
Functions of Money
- A medium of exchange
- A measure of value (of goods/services)
- A store of value
- A method of deferred payment (allows for debts to be created)
Short Run
The period of time over which at least 1 factor input is fixed
Long Run
The period of time over which all factor inputs are variable
Marginal Returns
Refers to the additional output gained from increasing one unit of input (labour) while keeping all other inputs constant
Average Returns
Is the total output divided by the total input (units of labour). It provides a measure of efficiency or productivity over a period
Total Returns
Is the overall output obtained from a given level of input (units of labour)
The Law of Diminishing Returns
If increasing quantities of a variable input are combined with a fixed input, eventually marginal and then average output (product) of that variable input will decline.
Returns to Scale
How a firm’s output changes as it increases or decreases its inputs (labour, capital, etc.)
Increasing Returns to Scale
%ΔOutput > %ΔInput
Decreasing Returns to Scale
%ΔOutput < %ΔInput
Constant Returns to Scale
%ΔOutput = %ΔInput
Fixed Costs
Costs which do not change with output e.g. insurance, rent, business rates – these still have to be paid even if the firm does not manufacture anything.
Variable Costs
Costs which change with output – the more that is made the higher these costs will be e.g. raw materials, components, energy.
Total Costs
Fixed Costs + Variable Costs = TOTAL COSTS
Average Costs
How much it costs to manufacture each item
Marginal Costs
The addition to total cost of producing one extra unit of output
Short-run Costs
Short-Run Costs include both fixed and variable costs, but some factors (like the size of the factory) are fixed.
Long-run Costs
Long-Run Costs encompass all costs, and all factors of production, including the size of the facility, can be adjusted
Reason for the shape of the Marginal Cost Curve
U-Shaped Curve:
Initially decreases due to increasing specialization, then increases due to diminishing returns
Reasons for the Shape of Average Cost Curve
U-Shaped Curve:
Similar to the marginal cost curve, reflecting economies of scale and then diseconomies of scale.
Reasons for the Shape of the Total Cost Curve
Rises Steadily:
Due to the fixed costs that remain constant regardless of production level.
How factor prices and productivity affect firms’ costs of production and
their choice of factor inputs
If factor inputs become 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.
Internal Economies of Scale
These occur when a firm becomes larger. Average costs of production fall as output
increases
External Economies of Scale
Economies of scale, represented by a downward shift of the average cost curve, which arise from a growth in the size of the industry in which the firm operates.
Reasons for Diseconomies of Scale
- Workers feel alienated (small fish in a big pond)
- Communication becomes slow and inefficient
- Decision making becomes slow and inefficient
The relationship between returns to scale and economies or diseconomies of scale
Returns to scale increases when the output increases by a greater proportion to the
increase in inputs. For example, if input doubles, and output quadruples. This occurs where there are economies of scale
and factor inputs become more productive.
On the other hand, a doubling of input leads to a 1.5 times increase in output,
there are decreasing returns to scale. This is linked to diseconomies of scale, since it
occurs when factor inputs become less productive.
The relationship between economies of scale, diseconomies of scale and the shape of the long-run average cost curve
The long-run average cost (LRAC) curve is directly influenced by economies of scale and diseconomies of scale. Businesses frequently realise economies of scale during the early phases of industrial expansion, which results in a downward-sloping LRAC curve. The LRAC curve eventually hits a minimum point, which represents the smallest scale of production that is still efficient, after which diseconomies of scale take hold and the curve slopes higher.
The L-shaped long-run average cost curve
The L-shape curve is a development in cost theory from the traditional U-shaped
curve. It 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, such as if managerial costs
increase, they are offset by the economies of scale gained by technical or production
factors.
This means that in the long run, costs continue to fall, even if the pace of falling
output costs slows (shown by the flat part of the curve)
The concept of the minimum efficient scale of production
The point of lowest LRAC is the minimum efficient scale. This is where the optimum
level of output is since costs are lowest, and the economies of scale of production
have been fully utilised.
Marginal Revenue
The extra revenue earned from the sale of one extra unit.
It is the difference between total revenue at different levels of output.
Total Revenue
Calculated by price times quantity sold. This is the revenue
received from the sale of a given level of output.
Why is the AR curve the demand curve
The average revenue curve is the price of the good.
The relationship between average and marginal revenue
When demand is perfectly elastic, marginal revenue = average revenue.
The relationship between marginal revenue and total 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.
Profit
The difference between total revenue and total costs
Normal profit
TR=TC
Abnormal (supernormal) profit
TR>TC
The role of profit in a market economy
- Profit is the reward that entrepreneurs yield when they take risks and make investments
- An entrepreneur wants to avoid loss and gain profit, which makes them want to
innovate, so they can reduce their production costs and improve the quality of their products - Profits can be retain for investment, helps them avoid the costs of interest payments if they borrow money
- Incentive for new firms to enter the market
Invention
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.
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.
