Production, costs and revenues Flashcards
What is production
Output
What is productivity?
Way of measuring how efficiently a company/economy is producing its output
What is the formula for productivity?
Total output/number of units of labour
What does increased productivity do to average costs
Lowers average costs
What are the factors affecting labour productivity?
Technology
Training
Wages
Infrastructure
Motivation
What is productivity defined as?
The output per unit of input employed
What is division of labour?
Breaking the process down into a sequence of tasks, with workers assigned to particular tasks
What is the short run?
Period of time when at least one factor of production is fixed
What are the advantages of division of labour?
Replace labour with machinery
Lower labour costs
lower average costs
greater producivity
What are the advantages of specialisation?
-become better
-better quality and higher quantity
-more efficient production - more output
-reduced training costs
What are the disadvantages of specialisation?
Boredom
Countries become less self sufficient
Could lead to more structural unemployment
What is specialisation?
A worker only performing one task or a narrow range of tasks. Also different firms specialising in producing gs and s
What are the functions of money
A measure of value
A store of value
A standard of deferred payment (payed at later dates)
What is money
A medium of exchange
What is the long run?
Period of time when all factors of production can be varied
What are variable costs?
Do vary with output
What are fixed costs?
Dont vary with output - rent
What is the marginal cost?
Marginal cost is the extra cost incurred as a result of producing the final unit of output
What is the marginal product?
The additional output produced by adding one more unit of a factor input.
Where is productive efficiency on a costs diagram?
Where MC = AC
What is the law of diminishing returns?
If one variable factor of production is increased while other factors stay fixed, eventually the marginal returns from the variable factor will start to decrease
What is the average product?
The output produced per unit of factor input
When does the AP curve meet the MP curve
When AP curve is at the maximum
What happens to TP when MP is negative
TP decreases
What happens to TP when MP is 0
TP is at its highest
What are sunk costs?
Money that the owner puts into the business when starting up e.g rent or advertising
What are the two costs in economics
Implicit - Costs of factors of production
Explicit - opportunity cost
What do high fixed costs create
Large economies of scale with industries with high fixed costs and low variable costs
What does the LRAC curve show?
The minimum possible average cost at each level of output
Define total cost (TC)
All the costs involved in producing a particular level of output
Explain the shape of MC
MC decreases initially as output increases, then begins to increase in the short run because of the law of marginal diminishing returns
How do external EoS affect LRAC curve
Economies of scale - upwards
Diseconomies - downwards
Define average cost (AC)
Cost per unit produced
Explain what happens when the marginal cost is higher than the average cost
Average cost will rise because each extra unit will increase the average cost
How does internal economies and diseconomies of scale affects shape of LRAC
Internal Eos - Average cost falls as output increases
External EoS - Average cost rises as output increases
Explain what happens when the MC is lower than the AC
Average cost will fall because each extra unit will decrease the average costs
Why does technology shift LRAC
Firms can use factors of production more efficiently at all levels
What is returns to scale?
Describes the effect on output of increasing all factor inputs by the same proportion
Explain the graph for marginal product
At first MP increases - each unit of input added will add more output than the one before
–> as a result of specialisation
MP begins to fall becauseadding units of one factor of production, the other fixed factors will begin to limit the additional output
What is increasing returns to scale?
Increasing returns to scale is when an increase in all factor inputs leads to a more than proportional increase in output
Define average product
output produced per unit of factor input
What is constant returns to scale
Constant returns to scale is when an increase in all factor inputs leads to a proportional increase in output
How can productivity be improved?
Better training
Improved technology
What is decreasing returns to scale?
Decreasing returns to scale is when an increase in all factor inputs leads to a less than proportional increase in output
What are economies of scale
As the scale of production of a firm increases, the long run average cost falls
Why is returns to scale and economies to scale not the same thing?
Returns to scale describe how much output changes as input is increased
EoS describes reductions in average costs as output is increased
Risk-bearing EoS:
When a firm becomes larger, they can expand their production range.
Therefore, they can spread the cost of uncertainty. If one part is not successful, they
have other parts to fall back on.
Financial EoS:
: Banks are willing to lend loans more cheaply to larger firms, because they
are deemed less risky. Therefore, larger firms can take advantage of cheaper credit.
How do returns to scale affect costs
Increasing RtS - decreasing costs
Constant RtS - costs stay the same
Decreasing RtS - costs increase
What is the minimum efficient scale?
The minimum efficient scale of production is the lowest level of output at which the minimum possible average cost can be achieved - LRAC reaches lowest value
Managerial EoS:
: Larger firms are more able to specialise and divide their labour. They
can employ specialist managers and supervisors, which lowers average costs
What do firms with high fixed costs have?
Very large MES
Technological EoS:
Larger firms can afford to invest in more advanced and productive
machinery and capital, which will lower their average costs.
What is total revenue?
Total revenue is the revenue recieved from the sale of a given level of output
Purchasing EoS
Larger firms can bulk-buy, which means each unit will cost them less. For
example, supermarkets have more buying power from farmers than corner shops, so
they can negotiate better deals.
Marketing EoS:
Larger firms can divide their marketing budgets across larger outputs, so
the average cost of advertising per unit is less than that of a smaller firm.
How to calculate TR?
What is average revenue?
Average revenue is the revenue per unit sold
What is External EoS
Involve changes outside the firm
How to calculate average revenue?
TR/Q or the price each unit is sold for
What are examples of external EoS
Infrastructure
Technology
Research and development
Education and training
Why is the AR curve the demand curve?
Because the average revenue curve is the price of the good
What is diseconomies of scale
When an increase in the scale of production leads to increases in the long run average costs
What is marginal revenue?
Extra revenue earned from the sale of one extra unit
What is a price taker?
A firm that has no power to control the price it sells at - have to accept the price set by the market
What are the causes of diseconomies of scale
Control
Coordination
Communication
What PED is the demand curve of a price taker
Perfectly elastic (flat)
What would happen if a price taker raises price?
Quantity sold will drop to zero
What demand curve is AR = MR
Perfectly elastic demand curve
When is TR maximised on a downward sloping demand curve?
When PED = -1
Why is demand elastic to the left of the midpoint of demand curve
Because decreasing a products price towards the midpoint will cause a more than proportionate increase in sales and TR will increase
Why is demand inelastic to the right of the midpoint of demand curve
Because decreasing a products price below the price at a midpoint will cause a less than proportionate increase in sales and total revenue will decrease
When is TR at its maximum
When MR = 0
How to calculate profit?
Profit = Total revenue - total costs
Where does normal profit occur?
TR = TC
What profit is where ‘economic profit’ = 0
normal profit
What is normal profit?
Minumum reward required to keep entrepreneurs supplying their enterprise or when the revenue left over from money costs is equal to opportunity costs
What is supernormal profit in term of revenue and costs
TR > TC
What does supernormal do?
Incentivises firms to try to enter the industry
What is supernormal profit?
Exceeds the value of opportunity cost of investing funds into the firm
Do loss making firms shut down in the short run?
No because it has fixed costs to pay. It all depends on how its revenue compares ot its variable costs.
What happens if a firm cant make normal profit in the long run?
Close because revenue is not covering all of the costs
Even if it maked money profit, the factors of production could be used to better effect elsewhere
When will a firm continue to produce in the short run?
When total revenue is greater than its total variable costs - any revenue generated above the firms variable costs can contribute to fixed costs.
When will a firm shut down in the long run?
When the total revenue is less than the total variable costs
When is profit maximised?
When MC = MR
What do we assume firms are in economics
We assume that firms are short run profit maximisers
What should the firm do when MR > MC
Increase output because the revenue gained by increasing output is greater than the cost in producing it.
Why might a firms objective be to survive?
To survive in the short run by achieving normal profit, then once established maximise profits
What should firms do if MR < MC
Decrease output because the revenue gained by increasing output is less than the cost in producing it.
Where do firms produce when trying to maximise revenue?
When MR = 0
Why do firms maximise profit at MR=0
Because marginal revenue is zero when total revenue has been maximised. Stopping short of this quantity means that an opportunity for more revenue has been lost
Where do firms produce if trying to maximise sales?
AR=AC
Why do firms trying to sales maximise produce at AR=AC
Because this is where the firm is achieving normal profits and it is the highest output consistent with this minimum requirement
What are examples of the principle agent problem?
Shareholders want to maximise profits for dividends / Managing directors pay is linked to sales or revenue, so they may choose those things instead.
Employees are likely to aim to increase their own pay rather than maximising profits.
What does maximising profit in the long run lead to
Sacrifising profit in the short run
Why is sales maximisation good in the short run and long run
Short run - lowers prices (consumer surplus)
Long run - increases market share, can give greater monopoly pricing in the long run
Why might firms choose to sales or revenue max instead of profit max in the short run
To increase market share, monopoly power or to borrow money more easily.
What is Corporate social responsibility?
When firms operate in a way that brings benefit to society, as well as trying to make supernormal profit
What are examples of corporate social responsibility?
By protecting the environment by using sustainable recourses
Supporting local businesses by using suppliers in their region
Choose to pay its workers above standard market rate
Why might firms choose CSR as an objective
Can increase profits by encouraging consumers to buy from them
What is the divorce of ownership and control
Where owners raise finance by selling shares. The shareholders are part owners of the company. However there is usually a board of directors which control the business and day to day decisions.
What is the principle agent problem?
This is where a principle e.g. the shareholders, pay for an agent (director) to act in the principles interests, but instead the agent acts in their own self interest
What are the characteristics of a perfectly competitive market?
Infinite number of buyers and sellers
Price takers
Consumers have perfect information
Producers have perfect information ( no secret cost method)
No barriers to entry/exit
Firms are profit maximisers.
Why does perfect competition lead to allocative efficiency?
Because the price machanism ensures that producers supply exactly what consumers demand , P = MC, P = MU
Why does the price mechanism work perfectly in perfect competition?
Firms are price takers - rationing recourses and signalling priorities
Perfect nowledge and no barriers means firms act on incentives
What does a market supply curve equal to in perfect competition and why
Marginal cost - because producers marginal costs increase as quantity increases due to the law of diminishing returns.
Do perfectly competitive firms make supernormal profit in the long run?
no
Why do perfectly competitive firms not make supernormal profit in the long run?
Supernormal profits attracts firms to the market (no barriers to entry), so supernormal profits are competed away
Explain why PC firms cant make supernormal profit
If an industry has a high demand, and a firm makes supernormal profits.
Those supernormal profits leads to other firms entering the market as there is no barriers to entry
Outward shift in supply
Market price falls until all excess profits have been competed away.
What happens to firms making subnormal profit in the long run
Exit the market
What happens to firms unable to make profit in the short run
If the selling price is above the average variable costs, the firm can trade temporarily
If the selling price is below the average variable costs, the firm will exit immediately
What is productive efficiency for firms?
When AC is at the lowest point - so prices can be low
Why is there productive efficiency in perfect competition?
As a result of firms trying to maximise profits.
Why do firms need to keep their x-efficiency as low as possible in perfect competition?
Strong incentive to remove waste and inefficiecy, cus if not they will have to leave the market
What is x-inefficiency
Also known as organisational slack. Its when a firm lacks the incentive to control costs e.g. bonuses, expenses - paying too much for factors or production or employing too many people
What is dynamic efficiency?
Improving efficiency, thus improving factors of production (R&D or new technology)
Do perfectly competitive firms have the means for dynamic efficiency?
No because they dont have supernormal profits, so there is no reward for their risk
Do perfectly competitive firms have the incentives for dynamic efficiency?
No - any supernormal profits are eroded by new entrants into the market, so prices fall and so does output
What is statically efficient?
Allocative and productive efficient.
Are perfectly competitive firms statically efficient?
Yes
What are ways perfectly competitive firms through non-price competition
Advertising, improved products, better quality, nicer packaging etc
Why might firms try to encourage competition in markets?
Increase in efficiency (Static efficiency and x efficiency)
Set fair prices
Innovation, more choice, and new production processes
What are some policies the government could implement to increase competition?
Start up subsidies
Privatise and deregulate large monompolisitc nationalised industies
Discourage mergers and takeovers
Encourage more international competition
