Revenues, Costs and Profits Flashcards
What is TR and the calculation
total revenue and is quantity x price
what is AR calculation
is equal to demand so = total revenue / output
what is MR calculation
change in total revenue / change in output
Why will some firms have a perfectly elastic (horizontal) demand curve
They are in perfect competition so have no price setting powers
why do firms have a downward sloping demand curve
price decreases as output increases this is imperfect competition so firms have some price setting powers
If Marginal revenue is positive what happens to elasticity of the demand curve
It is elastic
If MR is negative what happens to elasticity of the demand curve
It is inelastic
If MR=0 what happens to the demand curve
It is unitary elastic
Why does MR = AR in perfect competition
demand is perfectly elastic so price is the same no matter the output level, cost of producing another is the same every time as all goods are the same price
Why is TR curved in imperfect competition
At first total revenue rises with output when marginal revenue is positive, but when marginal revenue is negative so the cost of producing another is more than the revenue then total revenue will begin to fall as output rises
What is always fixed in the short run
At least one factor of production so some costs
What does the cost of production consist of
- monetary cost of factors of production having to be paid for
- opportunity cost of the factor of production and moneys next best use
What happens to costs in the long run
All costs are variable
TC what is it and formula
Total cost, cost at a given level of output
Fixed + variable
TFC what is it
Total fixed cost, don’t change with output
give examples of fixed costs
machinery or rent or salary
TVC what is it
Total variable cost, change directly with output
examples of variable costs
raw materials
ATC,AFC,AVC formula
average costs
formula is always / output
MC what is it and formula
marginal cost, extra cost of producing another unit
change in total cost / change in output
What is the law of diminishing returns
If one variable factor of production is increased while other factors stay fixed, marginal returns from the variable factor will begin to decrease
What is the other name for the law of diminishing returns
diminishing marginal productivity
Explain the law of diminishing returns in context
- Labour as a variable factor can be changed by employing more workers
- To begin with this may increase productivity and efficiency as more workers operate machines
- Eventually the firm will employ too many workers so there isnt space on any more machines and workers getting each others way which decreases productivity and thus decreases output.
What is the relationship between marginal returns and marginal cost and why does this happen
inverse because less additional output from each unit of input means costs are higher
Why does the AFC curve fall over time
the cost stays the same but output increases so the proportion of the cost is smaller
why is the ATC a U curved
costs fall initially because resources are used more efficiently, until resources are overused and efficiency falls so costs rise
Why is AVC a U curved that increases with output
The same reason as ATC but it increases with output because AFC stays the same throughout so AVC holds a larger proportion of the costs as output increases
Where does MC always cut the AC curve
lowest point
What is the relationship between MC and AC
If MC is below AC AC will begin to fall because the cost of producing another is below the average cost, the inverse is also relevant
Why are LRAC curves U shaped
Economies and diseconomies of scale
Why do firms operate on a SRAC
firms have at least one fixed factor of production
How can firms move along the SRAC
by increasing variable factors of production to increase output
How can firms shift the SRAC
When a firm changes all of their factors of production, this is only possible in the long run
What does the LRAC show
The minimum possible average cost at each level of output
How can firms operate on the LRAC
by utilising all factors of production to reduce costs to the minimum level
what does SRAC1 experience
economies of scale
what does SRAC3 experience
constant returns to scale
what does SRAC5 experience
diseconomies of scale
What causes movement along the LRAC
Changes in output changing the AC due to internal economies and diseconomies of scale
What causes LRAC to shift
External economies and diseconomies of scale like taxes or new tech because this changes the average cost at a given level of output
What is the minimum efficient scale
The lowest level of output at which the minimum AC can be achieved, higher AFC higher the MES
economies of scale
advantages of large scale production that allow lower average costs, so experience increasing returns to scale
increasing returns to scale
Increase in inputs will lead to a greater increase in output
constant returns to scale
increase in inputs leads to a proportional increase in output
decreasing returns to scale
Increase in inputs leads to a smaller increase in output
diseconomies of scale
disadvantages from being a large business that increases costs and causes decreasing returns to scale
Internal economies of scale
Advantage that a firm can enjoy because of the growth of the firm
What are all the types of internal economies of scale
Technical
Purchasing
Managerial
Financial
Risk Bearing
Marketing
Technical economies of scale
- specialised workers and machines are more efficient
- Production line methods, balanced teams of machines
- Increasing dimensions, storage or factories
- R and D
Explain how increasing dimensions is an economies of scale
If you build a new ware house and double the size of the walls, this will quadruple the area and make the volume 8 times greater, you get more storage for each pound spent
Purchasing Economies of scale
- Larger firms need larger quantities of raw materials so can negotiate better deals
- Large firms will also be very important to the supplier so the firm can bargain the cost even lower
Financial Economies of Scale
- Larger firms can borrow at lower rates and with more ease as they are seen as less risky to banks
- More security as they have many more assets to sell
Managerial Economies of scale
- Larger firms can employ specialist managers who have expertise in that area so that area will be more reliable and efficient
- reduces management cost per unit as management doesn’t increase directly with production
Risk Bearing Economies of Scale
- Large firms will diversify into different markets or products so that if one area fails then the whole business won’t collapse
- This means they can take more risks as failure can be absorbed by other areas of the firm
Marketing Economies of Scale
- Advertising is a fixed cost so the more they produce the less cost per unit for advertising
- Larger firms also benefit from brand awareness which makes their advertising more successful or eliminates the need for advertising
External economies of scale
Advantage which arises from a growth in the industry not the firm
examples of external economies of scale
- Local schools and colleges develop courses providing people with qualifications to work in the firm
- Large companies may collect in an area making recruiting costs lower and other costs lower like supply
- Large company in an area can improve infrastructure
- corp tax reduction
Internal Diseconomies of Scale
- Wastage and loss can increase as materials may seem in plentiful supply
- communication between areas of firm and between management levels and ownership may worsen
- More difficult to coordinate al aspects of the business
- Workers may feel alienated and like their work doesn’t matter in a large firm so become less efficient
- Increase transport costs
External Diseconomies of Scale
- whole industry becomes bugger price of raw materials may increase due to demand increasing
- buy large amounts of materials may mean they have to be bought from different suppliers which doesn’t make them cheaper per unit
What creates larger economies of scale
Higher fixed costs as these stay the same when output increases
What is the other profit maximisation condition
When TR and TC are furthest apart possible
Normal profit
When a firm covers its costs, sufficient revenue to keep all factors of production working, AR=AC or TR=TC
What is it called when profit is greater than normal
supernormal
Under what condition should a loss making firm continue production
AVC < AR as each good is creating more revenue than it cost to make so over time they can pay off their fixed costs and begin to reduce the loss size
Under what condition should a loss making firm shut down immediately
AVC > AR as it is costing more to produce a good than the revenue the good is bringing in
When may a AVC < AR firm making a loss need to shut down
When their fixed costs increase
What is the short run shut down point and why
AVC = AR because this means they aren’t reducing the size of their loss their revenue needs to be covering their variable costs in the short run
What do firms have to make in the long run
At least normal profit
