Profit, Revenue and Costs Flashcards
Average Cost
Total cost divided by the number of units produced
AC = TC / Q
Average Revenue
Total revenue divided by the number of units produced
AR = TR / Q
Marginal Revenue
The increase in revenue resulting from an additional unit of output
MR = change in TR / change in Q
Total Revenue
TR = P x Q
Marginal Cost
The change in total costs resulting from increasing output by one unit
MC = change in Cost / change in Q
Total Cost
Variable and fixed costs of producing a good or service
TC = FC + VC
Variable Cost
Costs that vary directly with output
e.g. raw materials
Fixed Cost
Costs that don’t vary directly with output
e.g. rent, machinery
Short Run Cost
When at least 1 FoP is fixed
MC and AC curves
Firms spread out fixed costs as they are more efficient at using them - they use up spare capacity
Firms increase output by employing more workers
Specialisation causes MC to fall
After optimum level of production, AC rises as workers become less efficient so factory operates beyond existing fixed capacity
Long Run Cost
When all FoPs are variable
In long run firms move to a bigger factory / expand, exploiting all economies of scale to reach MES
Danger of reaching diseconomy of scale due to poor communication + management etc.
In very long run an improvement in technology can lead to a fall in LRAC but this is expensive and needs firms to be retrained
Minimum Efficient Scale (MES)
When the unit cost is at its lowest possible point while the company is producing its goods effectively
Internal Economies of Scale
When a firm increases output, there is a fall in LRAC
Causes of Internal Economies of Scale
Research / Risk Bearing
Financial
Marketing
Technical
Managerial
Purchasing
Research / risk bearing economy of scale
Large firms can bear business risks more effectively than smaller firms
Larger firms invest in R+D → more productive processes → fall in LRAC
e.g. Apple
Financial economy of scale
Larger firms are more credit worthy to financial markets so are given lower rates of borrowing
Larger firms have more assets → higher credit rating → banks are more willing to lend money at lower interest rates → fall in LRAC
e.g. Costa vs independent coffee shop
Managerial economy of scale
Large scale firms can employ specialists who are more productive
Large firms can employ specialists → more efficient → fall in LRAC
e.g. F1 pit crew vs regular engineer
Technical economy of scale
Large scale firms can invest in expensive and specialist machinery and spread the cost over a large number of units
Larger firms can invest in capital → more productive processes → fall in LRAC
e.g. Tesco using automated tills
Marketing economy of scale
Large firms can spread advertising and marketing costs over a larger output
Spread advertising and marketing costs over a larger output → fall in LRAC
Purchasing economy of scale
Larger firms have more bargaining power with suppliers as they are bulky buying and so get discounts
Larger firms can negotiate to buy at lower costs → fall in LRAC
External Economies of Scale
As an industry grows, there is a fall in LRAC for all firms inside the market
Causes of External Economies of Scale
Technological breakthrough
Improved transport networks
Knowledge economies - pool of skilled labour, university research
Diseconomies of Scale
An increase in long run average cost as output increases
How to avoid diseconomies of scale
Worker recruitment, training, promotion, retention and support of faculty and staff
Performance related pay schemes
Engaging in out-sourcing of manufacturing
Normal profit
Total revenue is equal to total cost (implicit and explicit cost)
Supernormal profit
Total revenue is greater than total cost
Loss
Total revenue is less than total cost
