Production, Costs and revenue Flashcards
Define Marginal Returns of labour
The addition to total output brought by adding 1 more worker to the labour force
What is the law of diminishing marginal returns
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
What are the assumptions of the law of diminishing marginal returns
It’s in the short run, firms have fixed factors of production and state of technology is constant
What context is the law of diminishing marginal returns usually used in
Adding an increasing amount of labour to a fixed amount of capital
Diagrams for law of diminishing marginal returns
Beige color is diminishing marginal returns
Instead of product, say returns
In the blue parts, workers start to get in each others way
Define returns to scale
The rate by which output changes if the scale of all the factors of production is changed
Define increasing returns to scale
How does this affect the LRAC
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
Define Constant Returns to scale
When the scale of all the factors of production employed increases at the same rate
Define Decreasing returns to scale
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
What is a plant
An establishment, such as a factory, workshop or retail outlet owned and operated by a firm
Explain firm growth in terms of returns to scale in the long run
What diagram can be used to show this
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
What does plant size represent
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
What is the minimum efficient scale
The minimum output required to exploit full economies of scale
After this output, costs won’t go any lower
Diagram to explain Long run Production Theory
Left side of blue line is Q* = Minimum Efficient Scale
Define Optimum firm size
The size of firm capable of producing at the lowest average cost and thus being productively efficient
Name 4 types of diseconomy of scale
Control
Communication
Coordination
Motivation
What are external economy of scale
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
What are external diseconomy of scale
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
Give an explanation for the variability in the size of firm in different market/industry structures
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
Total costs diagram
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
Explain the shape of the TVC curve
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
Diagram for Marginal cost and Average Cost
Explain the MC/AC diagram
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
What are the revenue curves in a PCM
Explain them
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
Revenue curves in any imperfectly competitive market, including monopolies
Explain the revenue curves in any imperfectly competitive market, including monopolies
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
Why is AR=D
As AR is the price of a good
The goods price is determined by demand for it
Demand going up, price go up
Define Total revenue
All the money recieved by a firm from selling its total output
Define Average Revenue
Total revenue divided by output
Define Marginal revenue
Addition to toal revenue resulting from the sale of one more unit of the product
Define Profit
The difference between total sales revenue and total cost of production
Define Normal Profit
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
Define Supernormal profit
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
Define Subnormal profit
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
How are the 3 types of profit shown on a diagram
Normal : AR=AC
Supernormal : AR > AC
Subnormal : AR < AC
Explain 4 roles of profit in a market economy
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
Define Invention
The process of creating a new product/new way of making a product
Define Innovation
Improving/contributing to an existing product
Explain 4 things that technological change can have an impact on
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
Define Dynamic Efficiency
Occurs in the long run
Leads to the development of new products and more efficient processes that improve productive efficiency
How can the market structure have an impact on technological change
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
What is creative destruction
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
Who developed the theory of creative destruction
Give an example of it in action
Joseph Schumpeter - economist
Netflix putting Blockbuster out of business
Define Productive Efficiency
The level of output at which average costs of production are minimized
Define Quantity Setter
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
