Production Costs And Revenues Part 1 Flashcards
What is production?
A process that converts inputs such as the services of factors of production from capital and labour into a final output.
What does production end up doing?
Satisfying customers
How is production calculated?
Output per worker per period of time
What does being more productive mean?
The same input produces more output
(You produce more over the same period of time)
An input may be n. Workers
What does being less productive require?
An input to become larger whilst the quantity of output stays the same
Or the quantity of output to decrease whilst the input stays the same
How may you increase productivity?
Training workers
Using machinery
What is another way to say that a firm is more productive?
The average cost of unit has decreased
When does specialisation occur?
When each worker completes a specific task in the production process
Who stated the concept of specialisation?
Adam Smith
What did Adam Smith do?
What does this lead to?
He was an economist
He invented the idea of specialisation
He showed that through the division of labour worker productivity can increase.
Firms will then take advantage of this and increase productivity and lower average unit costs
Who can achieve specialisation?
Individuals
Businesses
Entire countries
(Pretty much everyone)
What are the advantages of specialisation?
Higher output
Potential higher quality
You can increase your portfolio as costs decrease
There are more opportunities for economies of scale therefore the size of the market could grow
More competition leading to an inventive to lower prices
What are the disadvantages of specialisation?
Work becomes repetitive which could lead to low motivated workers and therefore this could lead to a decrease in efficiency and low retention of staff etc
Employment may become more structural as skills may nit be transferable
It could end up decreasing product variety for the consumer
Could be higher worker turnover due to the repetitive nature of the job
What is a comparative advantage?
An economies ability to produce a good at a lower opportunity cost to another
When does absolute advantage occur?
When a country can produce more of a good with the same factor inputs
What are the advantages of specialisation in terms of trade?
Greater world output so there is a gain in economic welfare
Lower average costs as the market becomes more competitive
There is an increased supply of goods to choose from
There is an outwards shift in the PPF curve
What are the disadvantages of specialisation in terms of trade?
Less developed countries may use up their resources too quickly
Environmental damage is fossil fuels are used
Countries may become dependent on imports. Which could be disrupted.
What are the functions of money?
A medium of exchange
A measure of value
A store or value
A method of deferred payment
Explain the function of money: A medium of exchange?
A better system than bartering so that both people can get what they want
What was used before money?
What were the disadvantages?
Bartering
You could only get something if you had something that someone else wanted
Trades may not always be even
Explain the function of money: a measure of value
It gives us an ability to create a numerical value for things
Money also puts a value on labour
Explain the function of money: a store of value
It can be kept for a long time without expiring or becoming completely worthless
Explain the function of money: A method of deferred payment
It can allow for debts to be created so people can buy now and pay latter
What is the short run?
The scale of production is fixed - there is at least one fixed cost
What is the long run?
The scale of production is flexible so it can be changed - all costs are variable
What is the marginal return of a factor?
The extra output derived per extra unit of the factor employed
What is the average return of a factor?
The output per unit of input. (Output per worker) ÷ time
What is the total return of a factor?
(The total output produced by a number of units of factors) ÷ time
This amount of capital is fixed
Which do diminishing returns happen in. The long run or the short run?
Why?
Only in the short run
The variable factors could be increased in the short run. But over time the increase will become less productive so the marginal return of it falls. Then if you add another unit but it won’t produce as much as the additional unit
Therefore total output still rises but it increases at a slower rate
Ncruncicmkdme
What is diminishing marginal returns linked to?
How productive labour is
What does the law or diminishing returns assume?
Why may this not be true?
That firms have fixed factor resources in the shirt run and that the state of technology remains constant
There are increases in practices such as out-sourcing meaning that firms can cut their costs and their production can be flexible
What does returns to scale mean?
The change in output of a firm after an increase in factor input
When does returns to scale increase?
Give examples
When the output increases by a greater proportion to the increase in input
An increase of 2 (double) unit input and 8 (quadruple) units output shows an increase in returns to scale
An increase or 2 units input and 3.5 output shows an decrease in returns to scale
What are returns to scales linked to?
Diseconomies and economies of scale
What is constant returns to scale?
Where output increases by the same amount that inout increases by
In the short run what must be the case?
There must be some fixed costs
What must be the case for the long run?
All costs are variable
What are fixed costs?
Give some examples
Costs that so not vary with output. They are indirect.
Rent
What are variable costs?
Give an example
Costs that change with output. They are direct.
Raw materials
What is total cost?
How do you calculate it?
The cost to produce a given level of output
Total Cost = Total Fixed Cost + Total Variable Cost
TC = FC + VC
What is average cost?
How do you calculate it?
The cost per unit
Average Cost = (Total Costs) ÷ Quantity Produced
AC = TC ÷ Q
What is the marginal cost of production?
What can we infer about this?
The cost of producing one extra unit of output
We can infer, because of the law of diminishing returns, that after a point marginal cost rises as output increases
What shape is a short run average total cost curve?
Why?
U shape
Because of the law of diminishing returns.
And, since the factors of production are fixed at one point employing more resources will be less productive meaning that the marginal output decreases per extra factor of production. (Marginal costs start to increase)
Describe and explain a long run average cost curve
U shaped
At first the average costs decrease due to economies of scale until you get to the lowest point where you are at your optimum efficiency.
Then average costs start to increase due to diseconomies to scale
What happens if factor inputs become more productive?
A firm can produce more with the same level of input so the average unit cost decreases
What happens if factors of production become more expensive?
Firms will usually switch to cheaper means of production (and generally more productive) factor inputs such as capital
When do internal economies of scale occur?
When a firm becomes larger
What is internal economies of scale?
Average cost of production falls as output increases
(As a business gets bigger)
Give the examples of internal economies of scale
Really Fun Mums Try Making Pies
Risk bearing
Financial
Managerial
Technological
Marketing
Purchasing
Explain the example of internal economy: Risk bearing
As a firm gets larger they can expand their production range. Therefore, they can spread the cost of uncertainty so if one part fails they have another part to fall back on
Explain the example of internal economy: Financial
Banks are willing to loan money to more reliable firms. Therefore large firms may get more loan opportunities or better (cheaper) loans
Explain the example of internal economy: Managerial
Larger firms are more able to specialise and divide their labour. They can therefore employ specialise managers and supervisors. This may help lower average unit cost
Explain the example of internal economy: Technological
Larger firms can get capital intensive machinery reducing labour costs
Explain the example of internal economy: Marketing
Advertising is cheaper or they can do more
Explain the example of internal economy: purchasing
Bulk buying so the average unit cost will decrease
What is networking economies of scale?
The gains from the expansion of e-commerce. It makes it easier to sell as it is easy to access new customers and to display new/existing products
Where does external economies of scale occur?
Within an industry
(Smaller scale)
When does diseconomies of scale happen?
When a business gets to big and the average cost of production increases
Why may diseconomies of scale happen?
Control
Coordination
Communication
Explain the prompt of diseconomies of scale: Control
It becomes harder to monitor workers as you have too many so productivity may decrease
Explain the prompt of diseconomies of scale: Coordination
It becomes harder and more complicated to coordinate through employees and different branches of a business
Explain the prompt of diseconomies of scale: Communication
Workers could feel alienated and unappreciated. This could lead to low moral and therefore less production, staff retention…
On a long run average cost curve what does the turning point represent
The LRAC (Long Run Average Costs) is the minimum efficient scale
This is where the optimum level of output is since costs are at the lowest possible and economies of scale have been fully utilised
What is the difference between SRAC and LRAC?
Short run and Long run
What graph do you get when you combine the LRAC and the SRAC?
the LRAC curve
Describe and explain is the LRAC graph?
L shaped
It shows the relationship between the SRAC curve and the LRAC curve
The LRAC curve envelopes the SRAC curve.
The LRAC curve is always equal to or below the SRAC curve
SRAC falls at first but then increases due to the law of diminishing returns.
In the long run costs change due to economies and diseconomies of scale
If SRAC=LRAC the firm is operating where it can vary all factor inputs
The L shape of the curve (is a development of cost theory) as it suggests that:
At first costs per unit will fall as output increases due to economies of scale and because of this even if there are diseconomies of scale they will be offseted by economies of scale. This suggests that in the long run costs will continue to fall, even if the pace of falling output cost slows down (this is shown by the flat bit of the curve)
When does the LRAC shift?
When there is external economies of scale (when the industry grows)
What do we know when LRAC = SRAC?
The firm is operating where it can vary all factor inputs
Why is the L shape of the LRAC curve important?
The L shape of the curve (is a development of cost theory) as it suggests that:
At first costs per unit will fall as output increases due to economies of scale because of this even if there are diseconomies of scale they will be offseted by economies of scale. This suggests that in the long run costs will continue to fall, even if the pace of falling output cost slows down (this is shown by the flat bit of the curve)
How is TR calucated
TR = Total Revenue
P X Q
Price X quantity sold
What is total revenue?
Price X Quantity sold. This is the revenue received from the sale of a given level of output
How do you calculate AR?
AR = Average Revenue
TR ÷ Q
(Total Revenue ÷ Quantity sold
What is average revenue?
(Total Revenue ÷ Quantity sold). This is the price each unit is sold for
What is marginal revenue?
The extra revenue earned from the sale of 1 extra unit. It is the difference between total revenue at different levels of output
What is the AR curve equal to?
Why?
Average revenue curve is the same as the demand curve
This is because the average revenue curve is the price of a good
Why may the AR curve be horizontal?
All the firms are price takers
What does a horizontal AR curve show?
Perfect elastic demand for the good
MR = AR
What is profit?
The differnece between TR and TC
P = TR-TC
It is the reward that entrepreneurs get from taking risks
When is marginal revenue = average revenue
MR=AR when demand is perfectly elastic
What does marginal revenue measure?
MR measures the change in total revenue with respects to the change in the quantity of goods sold
How do you calculate marginal revenue?
MR= ΔTR ÷ ΔQ
Marginal revenue = the change in total revenue ÷ the change in quantity sold
What is normal profit?
Normal profit is the minimum reward required to keep entrepreneurs supplying their enterprise. It covers the opportunity cost of ingesting into the enterprise and not elsewhere.
T
Normal profit is when TR=TC. Normal profit is considered to be a cost, so it is included in the costs of production
What is supernormal profit?
The profit above normal profit.
So this exceeds the opportunity cost of investing. TR>TC
Why is profit useful in markets?
It encourages people to invest and take risks
It encourages competition
-Improves innovation
-Improves profit
-Increases efficiency
Can be used as a source of cash flow for the firm
It can be used as a guid of where profit can be made (for other new firms)
Factors of production are usually used in markets where the rate of retuned (profit) is highest
What is invention?
The process of creating a new product or a new way to make a product
What is innovation?
The act of improving or contributing to existing products
Why are technological advances normally good in reference to production, productivity, efficiency and cost of production?
It can result in improvement in efficiency and productivity. This could lower costs of production for a firm
The quality of goods could increase
The quantity of goods produced could increase
It can lead to the development of new products and markets
“Creative destruction”
Why are advances in technology bad in reference to production, productivity, efficiency and cost of production?
It could destory market
It could increase unemployment
It makes it harder for small and medium sized businesses to compete - we need SMEs to create competition so innovation is encouraged
Who proposed the idea of creative destruction?
Schumpeter
What idea did schumpeter suggest?
Creative destruction
This is the idea that new entrepreneurs are innovative, which challenges existing firms. This results in more productive firms making profit whilst the unproductive firms make losses and will drop out of the market. This could all result in an expansion of the economy’s productive potential
How can technological changes influence the structure of a market?
If competition is decreased as smaller firms can’t survive without machines monopolies will occur more often, and they will have less motivation on innovate due to the lack of competition. This means they will often be inefficient and their costs will be higher than they need to be.
Oligopolies tend to have a higher incentive to innovate since they are earning supernormal profit and they want to keep ahead of the competition.
Why is technological change in oligopolies quick?
Firms are trying to get ahead of other firms to keep making supernormal profit
