Production, Costs And Revenue Flashcards
What is production and productivity?
Production converts inputs, or the services of factors of
production such as capital and labour, into final output.
Productivity refers to the output produced per worker per hour.
What are benefits of specialisation and division of labour?
- Higher Productivity and Efficiency – Workers become more skilled at their specific tasks, increasing output.
- Lower Costs and Economies of Scale – Specialisation reduces waste and improves efficiency, lowering production costs.
- Better Quality and Innovation – Focused expertise leads to higher-quality products and technological improvements.
- Time-Saving – Less time is wasted switching between tasks.
- Increased Trade and Economic Growth – Countries can specialise in goods they produce efficiently and trade for others, boosting global output.
What is specialisation and division of labour?
Specialisation occurs when individuals, firms, or countries focus on producing a specific good or service in which they have an advantage.
Division of labour is a form of specialisation where the production process is broken down into separate tasks assigned to different workers.
Why specialisation requires an efficient exchange system?
When individuals or firms specialise, they no longer produce everything they need. This creates the need for exchange to obtain goods and services they don’t produce.
Money solves the problems of barter (direct exchange of goods), which has several limitations:
• Double coincidence of wants – Both parties must want what the other offers, making trade inefficient.
• Lack of divisibility – Some goods (e.g., cows) cannot be easily divided for small trades.
• Difficult store of value – Goods like food perish, while money retains value over time.
• Lack of standard measure – Barter makes it hard to compare the value of different goods.
Money provides a convenient, widely accepted, and efficient method for exchanging goods and services, making specialisation practical and beneficial.
What is difference between the short run and the long run?
At least one factor of production (e.g., capital, land) is fixed.
- Firms can adjust some inputs (e.g., labor, raw materials) but cannot expand factory size or invest in new technology easily.
- Diminishing marginal returns occur as more variable inputs (e.g., workers) are added to fixed resources.
- Example: A bakery can hire more workers but cannot instantly build a larger kitchen.
All factors of production are variable; firms can expand or reduce capacity.
- Firms can enter or exit the market.
- Economies of scale can be achieved, reducing long-term costs.
- Example: A car manufacturer can build a new factory and invest in automation over several years.
What is difference between marginal, average and total returns?
The total output produced by all units of a variable factor (e.g., labor) in the production process.
Increases at first, then slows down due to diminishing returns.
The average returns is output per unit of a variable factor, calculated as total output/ number of input unit.
Shows the productivity of each unit of input.
Marginal returns is the additional output from adding one more unit of input, calculated as change in total output divided/ change in input units.
When MP is above AP, AP is rising.
When MP is below AP, AP is falling.
Total returns rise as long as MP is positive, but begin to decline when MP becomes negative.
What is the law of diminishing returns?
Use the law of diminishing returns to explain the relationship between inputs and outputs
The Law of Diminishing Returns states that as more units of a variable factor (e.g., labor) are added to a fixed factor (e.g., land or machinery), the additional output (marginal return) from each extra unit of input will eventually decrease, holding all other factors constant.
It is when the additional output (marginal returns) from each extra unit of input decreases while all other factors constant.
In the short run, where at least one factor of production (e.g., capital, land) is fixed.
As more units of a variable factor (e.g., labor) are added to a fixed factor, marginal returns initially increase but eventually decline.
This occurs because the fixed factor becomes a constraint, leading to inefficiencies
What is returns to scale?
Returns to scale refers to how output changes when all inputs (labor, capital, land, etc.) are increased proportionally in the long run, when no factors of production are fixed.
Applies in the long run, where all factors of production (e.g., labor, capital, land) can be varied.
Describes how output changes when all inputs are increased proportionally.
What types of returns to scale?
- Increasing Returns to Scale (IRS)
Output increases more than proportionally to input growth.
Occurs due to specialization, improved efficiency, and economies of scale.
Example: If a firm doubles its inputs (workers and machines) and output triples, it experiences IRS. - Constant Returns to Scale (CRS)
Output increases exactly in proportion to input growth.
The firm maintains the same efficiency as it expands.
Example: If a firm doubles inputs and output also doubles, it has CRS. - Decreasing Returns to Scale (DRS)
Output increases less than proportionally to input growth.
Happens due to management inefficiencies, communication issues, and diseconomies of scale in large firms.
Example: If a firm doubles inputs but output only increases by 1.5 times, it faces DRS.
Why returns to scale matter?
Helps firms determine the most efficient level of production.
Influences cost structures—IRS leads to lower average costs, while DRS increases costs.
Important for business expansion and long-term planning.
Implications:
IRS → Lower costs → Competitive advantage (e.g., large-scale manufacturers).
CRS → Stable costs → Optimal efficiency (e.g., firms operating at ideal scale).
DRS → Higher costs → Risk of inefficiency (e.g., firms growing too large without proper management).
What is difference between fixed and variable costs?
Fixed Costs (FC),Variable Costs (VC)
Do not change with output.
Exist even if production is zero.
Examples: Rent, salaries, insurance, loan, repayments.
Change with the level of output.
Zero when no production occurs.
Examples: Raw materials, wages (for hourly workers), electricity used in production.
Total Cost (TC) = Fixed Cost (FC) + Variable Cost (VC)
What is difference between marginal, average and total costs?
Total Cost (TC)
The overall cost of producing all units.
TC = FC + VC
Average Cost (AC)
Cost per unit of output.
AC = TC/ Q
Marginal Cost (MC)
Additional cost of producing one more unit.
MC = change in TC/ change in Q
MC affects AC: When MC < AC, AC falls; when MC > AC, AC rises.
What is difference between shot run and long run costs?
Short-Run Costs
At least one factor of production is fixed.
Subject to the Law of Diminishing Returns.
Firms can only adjust variable inputs.
Long-Run Costs
All factors are variable.
Subject to Returns to Scale.
Firms can change all inputs, including scale of operations.
Short-run cost curves are U-shaped due to diminishing returns.
Long-run cost curves depend on economies or diseconomies of scale.
Why the shape of marginal, average and total cost curves?
Marginal Cost (MC) Curve
• Initially falls due to specialization.
• Rises due to diminishing returns (each additional input contributes less to output).
Average Cost (AC) Curve
• U-shaped because:
• First, spreading fixed costs lowers AC.
• Then, diminishing returns push AC up.
Total Cost (TC) Curve
• Upward-sloping because producing more units requires more inputs.
• Gets steeper when diminishing returns set in.
How Factor Prices and Productivity Affect Costs and Factor Choices?
Factor Prices
Higher input prices → higher costs → lower supply.
Lower wages → firms hire more labor instead of capital.
Productivity
Higher productivity → lower costs per unit → increased profits.
Firms choose the most cost-effective mix of labor and capital.
Choice of Factor Inputs
If labor is cheap and productive, firms use more labor (e.g., in developing countries).
If capital is more efficient, firms invest in automation (e.g., in advanced economies).
What is difference between internal and external economies of scale?
Internal Economies of Scale
Occur within a firm as it grows in size or scale.
The firm itself achieves lower costs through increased production.
Examples: Bulk purchasing, better use of machinery, specialized labor.
External Economies of Scale
Occur outside the firm, due to changes in the industry or market environment.
The entire industry benefits from lower costs as it grows, often due to industry-wide factors.
Examples: Improved infrastructure, better access to skilled labor, supplier specialization.
What can lead to diseconomies of scale?
Diseconomies of scale occur when a firm grows too large, leading to rising average costs. Some reasons include:
- Management inefficiency: As firms expand, they often face difficulties in managing a larger workforce, leading to communication breakdowns and slower decision-making.
- Worker alienation: Employees may feel less motivated and less productive in very large firms due to a lack of personal connection with the company.
- Coordination problems: Large firms can experience difficulties in coordinating activities between departments, which leads to inefficiency and higher costs.
- Increased bureaucracy: A rise in administrative costs and complex hierarchies can increase operational inefficiency.
- Overcrowding and poor use of resources: As firms expand beyond a certain point, they may face issues like overcrowded production facilities, leading to inefficiencies and higher variable costs.
What relationship between returns to scale and economies or diseconomies of scale?
Returns to scale describe how output changes when all inputs are scaled up in the long run.
Increasing returns to scale occur when output increases by a greater proportion than inputs, leading to economies of scale.
Constant returns to scale happen when output increases proportionally with inputs, leading to stable average costs.
Decreasing returns to scale happen when output increases less than the increase in inputs, leading to diseconomies of scale.
Thus, economies of scale correspond with increasing returns to scale, and diseconomies of scale correspond with decreasing returns to scale.
Relationship Between Economies of Scale, Diseconomies of Scale, and the Shape of the Long-Run Average Cost Curve (LRAC)
Economies of scale result in a downward-sloping LRAC curve as output increases and average costs decrease.
After a certain point, diseconomies of scale set in, causing the LRAC curve to slope upwards as output continues to increase, leading to higher average costs.
The LRAC curve typically U-shaped, reflecting:
Downward slope (economies of scale) at first.
Upward slope (diseconomies of scale) after reaching a certain output level.
Why long run average cost curve is L shaped?
An L-shaped LRAC curve occurs when a firm experiences continuous economies of scale for a long period before reaching a point of minimum cost.
The initial steep drop in the curve reflects significant economies of scale, while after the minimum efficient scale (MES), the curve flattens, indicating stable average costs.
This implies that the firm reaches an optimal scale of production and doesn’t experience much diseconomies of scale, even as it expands further.
What is minimum efficient scale of production (MES)?
Minimum Efficient Scale (MES) is the smallest output level at which a firm can achieve the lowest possible average cost.
At the MES point, a firm has fully exploited economies of scale, and further increases in output do not lead to significant cost reductions.
Beyond this point, if the firm continues to grow, it may begin to experience diseconomies of scale, and average costs may start to rise again.
It marks the point where average costs are minimized.
Firms must reach MES to be competitive in the market.
The MES is crucial for determining the optimal size of a firm in a given industry.
What is the difference between marginal, average and total revenue?
Total Revenue (TR)
The total income a firm earns from selling goods or services.
TR = P x Q (Price × Quantity)
Average Revenue (AR)
Revenue per unit sold; essentially the price of the good.
AR = TR/ Q
Marginal Revenue (MR)
The additional revenue gained from selling one more unit of output.
MR = change in TR / change in Q
In perfect competition: AR = MR = P , as firms are price takers.
In imperfect competition: MR < AR , because firms must lower prices to sell more output.
Why the average revenye curve is the firm’s demand curve?
Average Revenue (AR) = Price (P) because revenue per unit sold is just the price at which it is sold.
The AR curve represents the price consumers are willing to pay for different quantities, which is also the firm’s demand curve.
In perfect competition: The AR (demand) curve is horizontal because firms are price takers.
In imperfect competition: The AR (demand) curve is downward-sloping because firms must lower prices to increase sales.
