Production Costs and Revenues

Question 1

What is meant by production?

Answer 1

Production is the process or set of processes by which inputs are turned into outputs.

Question 2

What is the short-run in economics?

Answer 2

The short-run is a period of time (conceptual) in which at least one factor of production is fixed (eg land and capital)

Question 3

How do firms increase production in the short-run?

Answer 3

Firms can add variable factors of production eg labour and raw materials to a given number of fixed factors.

Question 4

What is meant by the long-run in economics?

Answer 4

The long-run refers to a period of time (conceptual) in which all factors of production are variable.

Question 5

How can firms increase production in the long-run?

Answer 5

In the long-run, firms can change the entire scale of their production as there are no constraints on the level of output produced.

Question 6

What is meant by productivity?

Answer 6

Productivity is a measure of output per unit of input (usually labour) in a given time period.

Question 7

What is meant by division of labour?

Answer 7

Division of labour is when workers are assigned different tasks in the course of production of a good or service.

Question 8

Why can total output increase if workers specialise?

Answer 8

-workers save time by not having to switch between tasks
-the idea that “practice makes perfect” so workers become more productive and efficient at a specialist task the more time they spend doing it

Question 9

What are advantages of specialisation and division of labour?

Answer 9

-more efficient use of scarce resources
-higher productivity (more output per unit of input)
-reduced costs for firms could lead to higher profits and therefore potentially:
•higher pay for workers
•investment in better capital
•lower prices for consumers

Question 10

What are disadvantages of specialisation and division of labour?

Answer 10

-unrewarding, repetitive work that requires little skill can lower motivation and eventually causes lower productivity
-workers may take less pride in their work
-dissatisfied workers causes absenteeism to increase
-people move to less boring jobs creating a problem of high worker turnover and increased hiring/training costs
-some workers receive little training and may not be able to find alternative jobs when out of work (they suffer structural unemployment/ occupational immobility)

Question 11

What is needed for specialisation to be economically efficient?

Answer 11

workers must be able to trade what they are specialist in producing at among eachother and they do this using a medium of exchange eg money

Question 12

Why is bartering considering inefficient?

Answer 12

Bartering is considered inefficient because there is rarely a double coincidence of wants.

Question 13

What is a medium of exchange?

Answer 13

A medium of exchange has its value recognised and accepted universally.

Question 14

What are fixed costs?

Answer 14

Fixed costs are costs of production which do not change with the level of output produced (rent, utility bills, interest payments on loans, salaries)

Question 15

What are variable costs?

Answer 15

Variable costs are costs that change with the level of output produced (raw material costs, delivery costs, packaging supplies, wages)

Question 16

What is the formula for total costs?

Answer 16

Total costs = fixed costs + variable costs

Question 17

What are sunk costs?

Answer 17

Sunk costs are costs that have already been incurred and cannot be recovered (rent, labour costs and costs of training/ hiring, expenditure on advertising and marketing, expenditure on R&D and product development)

Question 18

What are some examples of non-sunk costs?

Answer 18

-investment in capital can be retrieved if capital is sold to another producer
-ownership of land and buildings can be sold on
-deposits

Question 19

What is the formula for average cost?

Answer 19

Average cost = Total cost/ Quantity

Question 20

What is another formula for average cost?

Answer 20

Average cost = Average fixed costs + Average variable costs

Question 21

What is the formula for average fixed costs?

Answer 21

Average fixed costs = Total fixed costs / Output

Question 22

What is the formula for average variable cost?

Answer 22

Average variable cost = Total variable costs / output

Question 23

What is meant by productive efficiency?

Answer 23

Productive efficiency is achieved when output is maximised from all available inputs.

Question 24

Where is productive efficiency shown on the average cost curve?

Answer 24

A firm is productively efficient when it is producing at the minimum of its average cost curve.

Question 25

What is the law of diminishing returns?

Answer 25

The law of diminishing returns states that, in the short run, as variable factors of production are added to fixed factors, output will rise then fall.

Question 26

Why does the law of diminishing returns occur?

Answer 26

The law of diminishing returns sets in when fixed factors of production start to become overcrowded (variable factors get in the way of eachother) causing productivity to decrease.

Question 27

Explain the shape of the AC and AVC curves.

Answer 27

Specialisation means that cost per unit of output will fall (leading to a downward slope in curve). When the law of diminishing returns sets in and productivity of variable factors starts to fall, the cost per unit of output rises (upwards sloping curve)

Question 28

Explain the shape of the AFC curve.

Answer 28

The AFC curve continuously slopes downwards as fixed costs are spread over an increasing level of output. The gap between the AC and AVC curve is initially wide (at lower levels of output) and then starts to fall (as level of output increases) because as output increases, AFC comprises a decreasing proportion of AC.

Question 29

What are economies of scale?

Answer 29

Economies of scale are a fall in LRAC (per unit costs) as output increases

Question 30

What are diseconomies of scale?

Answer 30

Diseconomies of scale are a rise in LRAC (per unit costs) as output increases

Question 31

What is the difference between internal and external (dis)economies of scale?

Answer 31

Internal arise from growth within the firm and external arise from the growth of the market or industry in which the firm is operating.

Question 32

What are the 6 internal economies of scale?

Answer 32

-Risk-bearing: larger firms can diversify their output, leaving them less vulnerable to risk of sudden changes in demand and supply
-Managerial: larger firms can employ specialist managers to oversee employees and improve productivity in smaller departments of the firm
-Financial: larger firms can borrow (eg from banks) at more favourable interest rates because they are more reputable and safer to lend to
-Purchasing: larger firms can negotiate per unit discounts with suppliers when they bulk buy raw materials
-Technical: larger firms can obtain specialist capital that increases the efficiency of the production process
-Marketing: larger firms can negotiate per unit discounts with advertising/ marketing firms.

Question 33

What are the external economies of scale?

Answer 33

-Agglomeration: when firms in the same industry cluster together in close proximity to benefit from information sharing, pools of trained labour, supplier links and lower transportation costs eg silicon valley

Question 34

What happens to the LRAC curve when external economies of scale occur?

Answer 34

External economies of scale lower LRAC, hence the curve shifts downwards and the level of output stays the same with average costs decreasing

Question 35

What are the 3 internal diseconomies of scale?

Answer 35

-Alienation: workers in larger firms feel alienated due to a lack of recognition of their worth, which can lead to low morale, job dissatisfaction and poor productivity.
-Bureaucracy: as a firm becomes too big, administration of the firm becomes more difficult; inexperienced workers may be given managerial functions which can lead to poor decision making.
-Communication: a large firm with many layers of management may find it difficult to pass down communications from the top to the bottom, leading to communication failures, and disorganisation across the hierarchy.

Question 36

When do internal diseconomies of scale occur?

Answer 36

Internal diseconomies of scale occur when a firm expands beyond its optimum size (productive efficiency point), and starts to become productively inefficient.

Question 37

What do rising LRAC mean?

Answer 37

Rising LRAC mean diseconomies of scale and increase in average costs

Question 38

What are the external diseconomies of scale?

Answer 38

-Competition: agglomeration can also create competition among firms, which can raise average costs; competition for labour may cause average wages to increase, and there may be an increase in congestion in the area

Question 39

How do external diseconomies of scale affect the LRAC curve?

Answer 39

External economies of scale cause an upward shift in the LRAC curve and a rise in average costs at the same level of output

Question 40

What is specialisation?

Answer 40

Specialisation is when a worker performs only a task or a narrow set of tasks for which they are most productive.