Production, Costs and revenue

Question 1

Define Marginal Returns of labour

Answer 1

The addition to total output brought by adding 1 more worker to the labour force

Question 2

What is the law of diminishing marginal returns

Answer 2

When an increasing amount of a variable factor is added to fixed factors and the amount added to total product by each additional unit of the variable factor eventually declines

Question 3

What are the assumptions of the law of diminishing marginal returns

Answer 3

It’s in the short run, firms have fixed factors of production and state of technology is constant

Question 4

What context is the law of diminishing marginal returns usually used in

Answer 4

Adding an increasing amount of labour to a fixed amount of capital

Question 5

Diagrams for law of diminishing marginal returns

Answer 5

Beige color is diminishing marginal returns

Instead of product, say returns

In the blue parts, workers start to get in each others way

Question 6

Define returns to scale

Answer 6

The rate by which output changes if the scale of all the factors of production is changed

Question 7

Define increasing returns to scale

How does this affect the LRAC

Answer 7

When the scale of all the factors of production employed increases, output increases at a faster rate

So costs are rising, but output is rising at a faster rate, so LRAC falls, this is economies of scale

Question 8

Define Constant Returns to scale

Answer 8

When the scale of all the factors of production employed increases at the same rate

Question 9

Define Decreasing returns to scale

Answer 9

When the scale of all the factors of production employed increases, output increases at a slower rate

Costs are rising, but output is rising at a slower rate

So average costs are rising, this is diseconomies of scale

Question 10

What is a plant

Answer 10

An establishment, such as a factory, workshop or retail outlet owned and operated by a firm

Question 11

Explain firm growth in terms of returns to scale in the long run

What diagram can be used to show this

Answer 11

Initially, a firm can increase production in the short run by just adding variable factors of production.

However, after a point, short run diminishing marginal returns may kick in, so the firm will take the long run decision to invest in a larger production plant - increasing its plant size, hence having more fixed factors of production

Then the same thing will happen again in the short run with this now larger plant size

Returns to scale are about how much output changes once the plant size is increased

Question 12

What does plant size represent

Answer 12

Let plant size be the size of a firms fixed capital. So it cannot be changed in the short run.

The plant size also represents the total cost, so increasing plant size increases average cost

Question 13

What is the minimum efficient scale

Answer 13

The minimum output required to exploit full economies of scale

After this output, costs won’t go any lower

Question 14

Diagram to explain Long run Production Theory

Answer 14

Left side of blue line is Q* = Minimum Efficient Scale

Question 15

Define Optimum firm size

Answer 15

The size of firm capable of producing at the lowest average cost and thus being productively efficient

Question 16

Name 4 types of diseconomy of scale

Answer 16

Control

Communication

Coordination

Motivation

Question 17

What are external economy of scale

Answer 17

A fall in long run average costs of production resulting from the growth of the market or industry in which the firm is a part

Question 18

What are external diseconomy of scale

Answer 18

An increase in long-run average costs of production resulting from the growth of the market or industry of which the firm is a part

Question 19

Give an explanation for the variability in the size of firm in different market/industry structures

Answer 19

The existence/non-existance of increasing returns to scale

In some markets, the LRAC curve is horizontal - Large, small, medium firms can co exist and none have an advantage

In some markets, such for personal services (Personal trainers, hairdressers), economies of small scale production mean the LRAC curve is skewed to the left

Question 20

Total costs diagram

Answer 20

The difference between TC and TVC is the TFC, as you can see, the distance between the lines is constant

Fixed costs - costs that don’t change with output

Question 21

Explain the shape of the TVC curve

Answer 21

Costs that change with output

Assume the only cost of production is wages

Let point A be when the line is flat

Before A, there are increasing marginal returns, adding 1 extra worker(increasing cost) causes a larger increase in output

This gets very large around point A when the line is almost flat

After A, diminishing marginal returns kick in, workers start to get in each other’s way. Adding an extra worker(increasing cost) will decrease the increase in output produced

Question 22

Diagram for Marginal cost and Average Cost

Answer 22

Question 23

Explain the MC/AC diagram

Answer 23

Due to the law of diminishing marginal returns

When average cost is falling

Increasing Marginal Returns to scale, each extra worker is producing more, but costing the same, so average cost, marginal cost falls

When average cost is rising, there are decreasing marginal returns to scale

Each extra worker is producing less but costing the same. soo marginal/average costs rise

Question 24

What are the revenue curves in a PCM

Explain them

Answer 24

You can draw them on 1 diagram

Firms are price takers

Regardless of the no.of units, the price and so revenue of each unit is the same - so AR and MR won’t change

So TR will increase by the same amount each time

Question 25

Revenue curves in any imperfectly competitive market, including monopolies

Answer 25

Question 26

Explain the revenue curves in any imperfectly competitive market, including monopolies

Answer 26

Firms are price makers, so can change price with quantity sold

Average revenue decreases and Marginal revenue decreases twice as fast

So total revenue increases up to a maximum, the quantity at which MR=0. When marginal revenue become negative, the total revenue will start to decrease

Question 27

Why is AR=D

Answer 27

As AR is the price of a good

The goods price is determined by demand for it

Demand going up, price go up

Question 28

Define Total revenue

Answer 28

All the money recieved by a firm from selling its total output

Question 29

Define Average Revenue

Answer 29

Total revenue divided by output

Question 30

Define Marginal revenue

Answer 30

Addition to toal revenue resulting from the sale of one more unit of the product

Question 31

Define Profit

Answer 31

The difference between total sales revenue and total cost of production

Question 32

Define Normal Profit

Answer 32

The minimum profit a firm must make to stay in business and to keep factors of production in their current use, which is insufficient to attract new firms into the market

Question 33

Define Supernormal profit

Answer 33

Profit over and above normal profit

Exceeds the value of the opportunity cost of allocating factors of production elsewhere

In the long run, it attracts new firms to the market

Question 34

Define Subnormal profit

Answer 34

A loss

Profit is less than the profit that could be made by moving the factors of production elsewhere

So there is an opportunity cost

Question 35

How are the 3 types of profit shown on a diagram

Answer 35

Normal : AR=AC

Supernormal : AR > AC

Subnormal : AR < AC

Question 36

Explain 4 roles of profit in a market economy

Answer 36

Creation of incentives

Business finance

Retained profit can be used to invest instead of using loans that have interest

Signal to firms/consumers

Can attract new firms to market, when profit is higher than opportunity cost so factors of production are better allocated there

Allocative efficiency

Factors of production will move to markets where the rate of return is highest

Question 37

Define Invention

Answer 37

The process of creating a new product/new way of making a product

Question 38

Define Innovation

Answer 38

Improving/contributing to an existing product

Question 39

Explain 4 things that technological change can have an impact on

Answer 39

Productivity - methods of production

i.e through automation and mechanisation

Efficiency

Productive and dynamic efficiency

Costs of production

Lower firm costs - productive efficiency

Markets

Creative destruction

Question 40

Define Dynamic Efficiency

Answer 40

Occurs in the long run

Leads to the development of new products and more efficient processes that improve productive efficiency

Question 41

How can the market structure have an impact on technological change

Answer 41

In oligopolies, there are a few firms in fierce competition all making supernormal profit - have a higher incentive to innovate and get ahead

In monopolies, No competition = no incentive, there is static inefficiency

Question 42

What is creative destruction

Answer 42

The process of how capitalism leads to a constantly changing structure of the economy. Old industries and firms, which are no longer profitable, close down enabling the resources (capital and labour) to move into more productive processes.

So company closures and job losses are good for the long term wellbeing of the economy

Question 43

Who developed the theory of creative destruction

Give an example of it in action

Answer 43

Joseph Schumpeter - economist

Netflix putting Blockbuster out of business

Question 44

Define Productive Efficiency

Answer 44

The level of output at which average costs of production are minimized

Question 45

Define Quantity Setter

Answer 45

When a firm faces a downward sloping demand curve for its product. It posses the market power to set the quantity of the good it wishes to sell