Revenues, Costs and Profits

Question 1

What is the production function (model)?

Answer 1

A model that represents how the volume of output changes as factor inputs are increased.

Question 2

What are the assumptions of the production function?

Answer 2

• The firm uses only 2 factors (Labour and Capital)
• Capital is fixed in the short-run, but variable in the long run
• Labour is variable in both the short and long run

Question 3

What is Average Output?

Answer 3

Total Output/Fixed Capital

Question 4

What is Marginal Output?

Answer 4

The rate of change of the Total Output (as labour changes)

Question 5

Phase 1 of the production function:

Answer 5

The workers are becoming more specialised and so more productive

Question 6

Phase 2 of the production function:

Answer 6

When increasing labour combined with fixed capital, eventually there will be diminishing returns (but there is still increase output)

Question 7

Phase 3 of the production function:

Answer 7

As labour increases the marginal output becomes negative because workers are becoming less efficient (crowded, distracted etc)

Question 8

What is Total short-run fixed costs?

Answer 8

Costs which don’t vary as output varies

Question 9

What is Total short-run Variable Costs?

Answer 9

Costs which vary as output varies

Question 10

What is Total short-run costs?

Answer 10

TVC + TFC

Question 11

What is the LRAC

Answer 11

Total (LR) costs / Output

Question 12

What does the LRAC looklike

Answer 12

U shape (flatter), is made up of lots of little SRAC curves

Question 13

Define Economies of Scale

Answer 13

A proportionate saving in costs gains by an increased level of production

Question 14

What are purchasing economies of scale

Answer 14

Bulk-buying discounts, so a lower average cost per unit as a reward for buying more

Question 15

What are managerial economies of scale

Answer 15

As a business increases its scale of production, it can employ more/specialised managers so the company becomes more efficient, thus increases output by more than the cost of employing them

Question 16

what are technical economies of scale

Answer 16

As firms increase scale (increased profits), they can employ specialist/better machinery and therefore become more efficient

Question 17

what are risk bearing economies of scale

Answer 17

Firms can spread risk across their companies, if a firm is bigger the shock is a smaller proportion of their cost

Question 18

What are financial economies of scale

Answer 18

Larger businesses are likely to have a greater stock of assets to borrow against, so they can access credit (e.g., loans), so they will have lower average costs due to lower borrowing costs

Question 19

What are diseconomies of scale?

Answer 19

The size of firms can become a burden, leading to an increase in LRAC

Question 20

Examples of diseconomies of scale

Answer 20

• Control: can’t monitor productivity + quality
• Coordination: difficult to coordinate complicated production processes across several plants
• Co-operation: workers in large firms feel alienation and loss of morale

Question 21

What is Total Revenue?

Answer 21

Price x Quantity

Question 22

What is Average Revenue?

Answer 22

Total Revenue / Output = PxQ / Q = Price

Question 23

What is Marginal Revenue?

Answer 23

Change in TR / Change in Output

Question 24

What is the relationship between AR and MR

Answer 24

MR is always below AR, so if AR is falling MR must be falling too
The MR has twice the gradient of the AR curve

Question 25

What is the relationship between MR and TR

Answer 25

When the TR begins to decrease (turning point) the MR crosses into negative. Because the MR is the gradient function

Question 26

What is accounting profit

Answer 26

Total Revenue - Total (production) costs

Question 27

What is Economic Profit

Answer 27

Accounting profit - Opportunity cost (of pursuing this accounting profit)

Question 28

What is Supernormal profit

Answer 28

When the economic profit > 0

Question 29

What is Subnormal profit

Answer 29

When the economic profit < 0

Question 30

What is Normal Profit

Answer 30

When the economic profit = 0

Question 31

Profit is maximised at what point?

Answer 31

MC = MR,

Because it is the last point at which MR is above MC, so there has been the biggest increase in revenue

Question 32

What to do if AR is lower than ATC but greater than AVC

Answer 32

In the short-run they should continue in order to minimise the loss, in the long-run they should shut down

Question 33

What to do if the AR is lower than the ATC and AVC

Answer 33

Shut down immediately, will make more of a loss if you continue operating

Question 34

What is the difference between external and internal economies of scale

Answer 34

External are any factor which causes a firms LRAC to fall as a result of the industry/market growing in size

Question 35

What is the MES (minimum efficient scale)

Answer 35

The point on the LRAC where there are the lowest average costs