Production, Costs and Revenue Flashcards
Production
The conversion of inputs into a final output, satisfying consumer needs and wants
Productivity
Output per unit of input per period of time
Labour Productivity
Output per worker per hour
Increased Productivity
The same input will produce more output in the same period of time
Specialisation
When each worker completes a specific task in a production process. The division of labour allows for increased worker productivity
Advantages of specialisation
- Higher output as production is focused on what people/firms are best at
- More opportunities for economies of scale
Disadvantages of specialisation
- Work becomes repetitive, lower worker motivation and therefore productivity
- Increase structural unemployment as skills may not be transferrable
- Variety of goods/services for consumers may decrease
Short run
At least one of the factors of production is fixed
Long run
All factors of production are variable
Marginal product of a factor
The extra output derived per unit of the factor employed
Average return of a factor
The output per unit of input
Total return of a factor
The total output produced by a number of units of a factor over a period of time
Law of diminishing returns
- As more units of a variable factor of production are added to a fixed factor, the marginal product of the variable factor will eventually decline
- This occurs in the short run
Returns to scale
- The change in the output of a firm after an increase in factor inputs
- This occurs in the long run
Increasing returns to scale
The percentage increase to the output is greater than the percentage increase to the inputs
Decreasing returns to scale
The percentage increase to the output is smaller than the percentage increase to the inputs
Constant returns to scale
Inputs and output increase by the same percentage
Fixed costs
- Indirect costs that do not vary with output
- e.g rent, advertising, capital goods
Variable costs
- Direct costs that change with output
- e.g cost of raw materials
Total costs
- The cost to produce at a given level of output
- Total costs = total variable costs + total fixed costs
Average costs
- The cost per unit
- Average costs = total costs / quantity produced
Marginal cost of production
The cost of producing one extra unit of output
Short run average total cost curve
- It is U-shaped due to diminishing marginal returns as at least 1 factor of production is fixed (usually capital/land)
- Costs decrease initially as hiring more workers allows for productivity increase due to specialization and better use of fixed resources
- Costs increase at higher levels of output as the fixed factor becomes a constraint
Long run average cost curve
- Average costs initially fall as firms can take advantage of economies of scale and falling average costs
- After the optimum level of output average costs begin to rise due to diseconomies of scale
Internal economies of scale
- They occur when a firm becomes larger
- Average costs of production fall as output increases
- Risk-bearing, Financial, Managerial, Technological, Marketing, Purchasing
Risk-bearing economies of scale
When a firm becomes larger they can expand their production range, spreading the cost of uncertainty. If one part is unsuccessful they have the rest of the firm to fall back to
Financial economies of scale
Banks are willing to lend larger loans, and at lower rates, as large firms as deemed less risky
Managerial economies of scale
Larger firms can specialise and divide their labour, hiring specialist managers to boost output
Technological economies of scale
Larger firms can invest more into advanced machinery and capital, lowering average costs
Marketing economies of scale
Larger firms can divide their advertising budget across larger outputs, lowering the cost of advertisement per unit
Purchasing economies of scale
Larger firms can bulk buy, reducing unit costs as they have greater buying power
External economies of scale
- Lower average costs when the industry as a whole grows
- e.g infrastructure improvements, skilled labour pooling, support industries
Diseconomies of scale
- When output exceeds the optimum level and average costs start to increase per extra unit of output produced
- Control, Coordination, Communication
Control diseconomies of scale
It is harder to monitor workforce productivity as the firm expands
Coordination diseconomies of scale
It is harder to coordinate workers so that they are all working efficiently as the firm expands
Communication diseconomies of scale
Workers may feel alienated as the firm grows, leading to falls in productivity as motivation decreases
Minimum efficient scale
The lowest point on the LRAC curve (the optimum level of output)
L-shaped LRAC curve
The L-shaped LRAC curve suggests that average costs will not rise due to disconomies of scale - they will fall as economies of scale are utilised before becoming constant
- This is due to modern firms utilising better technology and outsourcing
Total revenue
- The revenue received from the sale of a given level of output
- Total revenue = quantity sold * price
Average revenue
- The price each unit is sold for
- Average revenue = total revenue / quantity sold
Marginal revenue
The extra revenue earned from the sale of one extra unit
Average revenue and demand curve
AR curve
- The AR curve is the same of the firms demand curve because it is the price of the good
- The AR curve is perfectly horizontal when firms are price takers, showing the perfectly elastic demand
Profit
The difference between total revenue and total costs
Normal profit
- The minimum reward required to keep entrepreneurs supplying their enterprise
- It must cover the opportunity cost of investing funds into the firm and not elsewhere
Supernormal profit
Any profit above the level of normal profit
Role of profit
- In a free market economy profit is the reward that entrepreneurs yield when they take risks and make investments
- Entrepreneurs want to maximise their profit so they are incentivised to innovate, reducing costs and improving quality
- Profit can be retained to act as a cheap source of finance
- Profit acts as a signal to firms, causing new firms to enter markets where firms are making supernormal profits
Innovation
The act of improving or contributing to existing products
Invention
The process of creating a new product (or new process to make an existing product)
Impact of technological change
- Improvements in efficiency and productivity, lowering costs of production for firms
- Affects market structures as it removes barriers to entry but may allow for greater monopoly power
- Generally creates higher skilled jobs but reduces demand for low-skilled workers
Creative destruction
The process by which new innovations replace outdated industries as new technologies emerge and allow for more efficient firms
Technological change in monopolies
Monopolies have no incentive to innovate due to a lack of competition
Technological change in oligopolies
Oligopolies have an incentive to innovate in order to get ahead of their competitors
