Revenues, Costs and Profits Flashcards
What is Price Maker?
a firm that has enough market power to influence the price of a good and faces a downward sloping D Curve
What is a Price Taker?
A firm that has to sell its good at the same price as other, doesn’t have enough market power to influence the Price
What is Total Revenue?
Amount of Money a firm receives
- Q x P
What is the shape / draw the TR curve of a Price taking firm + why?
- TR Curve straight line sloping upwards that goes through origin
- Operating in a very competitive market –> must accept market-determined price for products.
What is / draw the shape of a TR curve for price making firms +why?
- Upside down U (parabola) starting from origin
–> as price falls, revenues will rise (at a decreasing marginal rate) until a point of maximum revenue, then as price falls the TR will also fall
What is Average Revenue + formula?
- Price the firm receives per unit sold
- AR curve = D curve
AR= TR/Q
AR = PxQ / Q
What is the difference between a Price Makers AR curve and a Price Takers AR curve
Maker
- Downward sloping curve
Taker
- Horizontal (-) perfectly elastic curve
What is Marginal Revenue + formula?
- Change in total Revenue from selling one more unit
MR= △TR/ △Q
What is the difference between a Price Makers MR curve and Price Takers MR curve?
Maker
- MR curve downward sloping, has gradient twice as steep as AR curve (half the D curve)
Taker
- MR is horizontal (-) equal to AR curve
What is the relationship between PED and revenue?
- If D is Price Inelastic, (below 1) MR= Negative
–> TR will move in direction of price change
–> (e.g. TR go up if price increase, TR go down if price decrease) - If PED = Unitary (PED = 1) MR = 0
–> TR doesn’t change - If PED Elastic (Above 1) MR = Positive
–> TR moves opposite direction to Price
–> (e.g. cut Price –> ↑TR)
What is the formula for PED?
%△Qd / %△P
What is Total Cost + equation in SR?
- TC = Cost of producing at given output
TC = TVC + TFC
–> Total Fixed costs = costs do not change with output e.g. rent for building
–> Total Variable Costs = Costs do vary with output e.g. materials
Draw + Explain Total Fixed Costs curve + Total Variable Costs curve
TFC
- Straight horizontal line, across X-Axis Output , Y-Axis Cost
TVC
- Starts at Origin
- Inverse S (look up if don’t know)
–> increases then flattens then increases again but with smooth lines
What is Average Cost + Formula?
Cost per unit of output
AC= TC/Q
–> AC falls as Q increases as Fixed Costs spread over more products
What is Average Variable Costs + Formula
Variable cost per unit of output
AVC = TVC/Q
What is Average Fixed Costs Formula?
- AFC = TFC/Q
Draw AVC + MC + AC curves on a graph
MC = looks like a J Curve
AC = U curve starts starts high doesn’t end that high
–> trough of curve goes through MC
AVC = roughly follows AC, trough through MC, below AC, doesn’t start as high
What are Marginal Costs + Formula
- Costs to firm of making one more unit of output
MC = △TC/ △Q
–> decides gradient of TR curve
–> MC curve = the J looking curve
Relationship between MC (Marginal Cost) and AC (Average Costs)
- MC curve crosses AC curve at its lowest point
- When MC is below AC, cost of producing extra unit is below average cost of producing a unit
–> Extra unit ↓AC - When MC above AC, cost of producing extra unit more than average cost of producing a unit
–> extra unit ↑AC
Define the Short run Vs. Long run?
SR - Period of time where at least one FoP is fixed (Factor of production)
LR - Period of time where all FoP are variable
What is the Law of Diminishing returns?
- as more variable factors of production are added to fixed factors of Production, the increase in output eventually falls
–> only applicable in SR as in LR all FoP are variable
e.g. if more workers are added to a same size room, come a point where too many workers for room, adding workers will slow output down / decrease output instead of increasing
What is Average Production + Formula?
- Unit of output produced per unit of variable factor of production
AP= TP (total Product) / Q
What is Marginal Product + Forumla?
- Change in output resulting from one more unit of variable factor
MP = △TP (Total Product) / △Q
Relationship between MP curve and MC curve
Marginal Product
Marginal Costs
- As MP rises MC falls –> as MC rises MP falls
Relationship between AP and AVC
Average Product
Average Variable Costs
- As AP rises AVC falls, As AVC rises AP falls
What are Economies of Scale?
EOS
- When an increase in scale of production results in large increase in output, causing a fall in LR Average Costs
Internal Vs. External EOS
Internal
- LR Average Costs of production decrease as firms size increases
External
- When LR Average Costs of Production decrease as whole industry / market a firm is in size increases e.g. AI
What are 6 examples of Internal EOS
- Technical EOS –> e.g. larger warehouse, larger shop able to hold much more
–>Larger companies will own the machine as opposed to renting them - Marketing EOS –> cost of advertising spread over larger output / consumers e.g. Virgin ads Media, plane, gym in one
- Commercial EOS –> bulk-buying e.g. Walmart , P↓, Profit↑
- Managerial EOS –> Larger firms ↑Efficiency, highly skilled, specialised managers
- Financial EOS–> more collateral to borrow against, lower interest rates due to lower risk
–> - If a larger company needs liquidation it can sell shares.
–> contributes to lower AC - Risk-bearing EOS –> spread risk through diversification. e.g. Mars owning chocolates, pet food, rice.
What is Diversification?
- Firm increases range of goods or markets to reduce risk
What are Diseconomies of Scale?
- DOS
–> Increase in scale of production results in reduced increase, or decrease, of output –> ↑LRAC
What are some causes of DOS?
- X-inefficiency –> lack of competition for large firm means costs allowed to rise –> little incentive for firm to minimise costs
- Poor communication –> communication between manager / owners and workers become complex e.g. ↑Bureaucracy –> delays in info –> productivity ↓
- Principles-Agent Problem –> divorce from ownership + control (different gals between CEO [long-run] + managers [short-run])
- Demotivation –> large business often impersonal, ↓Efficiency of workers –> Productivity ↓
- Poor co-ordination –> e.g. different timezones, cultures countries –> productivity ↓ –> AC ↑
Name 3 factors contributing to External EOS
- University programs –> e.g. partnership between Standford + Apple (benfits both)
- Infrastructure –> Gov providing infrastructures / subsidies
- Popularity e.g. AI popular
2 Reasons of External DOS?
- Higher Rent in certain areas
- As Industry grows D for materials / workers / machinery increases
What is Profit?
- TR-TC
- reward for risk taking
What is the point Profit Maximisatoin occurs?
- MR=MC or Marginal Profit = 0
- When a firm cannot increase profits further
–> also be the output where TR-TC is largest
What equation do you use to work out %Change
New Price - Original Price (P2-P1) / Original Price (P1)
x 100
Formula for PED + inelastic vs elastic?
%△Qd / %△P
- Inelastic = Less than 1
Elastic = Greater than 1
Perfectly / Unitary Elastic = 1
3 types of Profit
- Normal Profit , AR = AC - minimum money required for a firm to remain in business
- Supernormal profits, AR>AC
- Loses , AR<AC
(All use Economic profits)
What are Economic Profits
Econ
Revenues - Economic (Implicit) Costs
- Implicit Costs e.g. Opportunity costs
Accounting
Revenues - Explicit Costs
- Explicit costs e.g. wages
Productive Efficiency; Formula + Explanation?
MC= AC
(Marginal Costs = Average Costs)
( J curve = top U curve )
–> Minimum point on AC, Lowest Cost per unit
Allocative Efficiency; Formula + Explanation?
P=MC
(Price = Marginal Costs [J curve] )
–> Price charged maximises social welfare, taking consumer + Producer welfare into account
Normal Profit; Formula + Explanation?
TR=TC or AR=AC
–> Return is built into cost curve, just enough profit to keep business going –> represents Oppertunity Cost
Profit Maximisation; Formula + Explanation?
MR = MC
Marginal Revenue = Marginal Costs
–> Marginal Profit = 0
–> Vertical difference between TR and TC is maximum
Sales Maximisation
AC= AR
TR=TC
–> highest level of output at normal profits
Revenue Maximisation; Formula + Explanation?
MR= 0
–> Maximum total Revenue
Selling another unit adds same to TR as amount lost from units being sold at lower price
Price taker; Formula (for graph) + Explanation?
AR=MR
- Perfectly elastic demand
–> TR is straight line through origin
AR + MR horizontal
PED infinite
Price maker; Formula (for graph) + Explanation?
- AR > MR
- AR downwards sloping
MR at twice gradient of AR (e.g. MR half of AR)
–> firm has price-setting power
Break-even; Where it is on graph + Explanation?
AR=AC
–> firm covers costs and makes only normal profits
Shut down point; Where it is on graph + Explanation?
AR=AVC
–> Firm only covers AVC, makes loss
- If price above this but below AC, still a loss, but firm contributes to AFC so can carry on in SR
What are the 5 types of Pricing Strategies
- Predatory Pricing –> illegal (CMA) When prices are set below AVC to drive competitors out
- Limit pricing –> prices are set below the profit maximising price but not so low losses are made (lower prices a lot but not to make loses)
- Pricing-meet the objectives –> Profit Max (MR=MC), Revenue Max (MR=0), Sales Max (AR=AC) (diagram)
- Cost-plus or Mark-up pricing –> firm calculates AC and add mark-up to make profits (used in irl)
- Price Wars
Explain Price wars (reasons for + company attitudes to it)
- Firms want to avoid Price wars –> Profit↓
Reasons for price wars:
- Defend Market Shares (dif firm lowers price)
- To drive weaker competitors out market
- Existing firms defending market against new firm (prefatory pricing)
Limit Pricing + Predatory pricing Evaluation (SR + LR etc.)
- Short-run - benefits consumers (P↓) harms shareholders (revenue↓)
- Long-run - harms consumers (P↑ - Og firm puts P back, eliminates possible innovation) benefits shareholders
- Possible price wars
- Anti-competitive behaviour (Predatory illegal CMA)
Sales Maximisation explained + evaluation points (2 ben, two con)
(graph, evaluation)
Graph
- Q=P where AVC = AR / D
Evaluation
pros
- EOS↑ (than Profit Maximisation)
- ↑ Brand awareness–> Circulation of products
cons
- Dividends ↓
- Profits ↓Dynamic Efficiency
What are the 6 type of buisness goals for a firm?
- Profit Maximisation –> Q = (MR=MC) P= AR
- Revenue Maximisation –> MR=0
- Sales volume Maximisation –> AC=AR
- Satisficing –> Principle agent problem
- Growth Maximisation –> ↑EOS
- CSR (Corporate Social Responsibility) –> community work / Charities
Revenue Maximisation explained + evaluation points
(graph, assumptions, evaluation)
graph
- Q where MR (1/2 D) = 0
- P follow line up to D
- MR=0
Assumption
- Managers most interested in salary, boost revenue for company
Evaluation
pros
- P↓ (Market share↑) –> EOS↑ (than Profit Maximisation)
cons
- Profit for shareholders↓ (than profit max.)
- P↓ may be copied by other firms, Profits don’t increase by much
What is Minimum Efficient Scale?
- the output where LRAC first reach a minimum
–> where internal EOS fully exploited
