Revenues, Costs and Profits Flashcards
What is the production function (model)?
A model that represents how the volume of output changes as factor inputs are increased.
What are the assumptions of the production function?
- 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
What is Average Output?
Total Output/Fixed Capital
What is Marginal Output?
The rate of change of the Total Output (as labour changes)
Phase 1 of the production function:
The workers are becoming more specialised and so more productive
Phase 2 of the production function:
When increasing labour combined with fixed capital, eventually there will be diminishing returns (but there is still increase output)
Phase 3 of the production function:
As labour increases the marginal output becomes negative because workers are becoming less efficient (crowded, distracted etc)
What is Total short-run fixed costs?
Costs which don’t vary as output varies
What is Total short-run Variable Costs?
Costs which vary as output varies
What is Total short-run costs?
TVC + TFC
What is the LRAC
Total (LR) costs / Output
What does the LRAC looklike
U shape (flatter), is made up of lots of little SRAC curves
Define Economies of Scale
A proportionate saving in costs gains by an increased level of production
What are purchasing economies of scale
Bulk-buying discounts, so a lower average cost per unit as a reward for buying more
What are managerial economies of scale
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
what are technical economies of scale
As firms increase scale (increased profits), they can employ specialist/better machinery and therefore become more efficient
what are risk bearing economies of scale
Firms can spread risk across their companies, if a firm is bigger the shock is a smaller proportion of their cost
What are financial economies of scale
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
What are diseconomies of scale?
The size of firms can become a burden, leading to an increase in LRAC
Examples of diseconomies of scale
- 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
What is Total Revenue?
Price x Quantity
What is Average Revenue?
Total Revenue / Output = PxQ / Q = Price
What is Marginal Revenue?
Change in TR / Change in Output
What is the relationship between AR and MR
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
What is the relationship between MR and TR
When the TR begins to decrease (turning point) the MR crosses into negative. Because the MR is the gradient function
What is accounting profit
Total Revenue - Total (production) costs
What is Economic Profit
Accounting profit - Opportunity cost (of pursuing this accounting profit)
What is Supernormal profit
When the economic profit > 0
What is Subnormal profit
When the economic profit < 0
What is Normal Profit
When the economic profit = 0
Profit is maximised at what point?
MC = MR,
Because it is the last point at which MR is above MC, so there has been the biggest increase in revenue
What to do if AR is lower than ATC but greater than AVC
In the short-run they should continue in order to minimise the loss, in the long-run they should shut down
What to do if the AR is lower than the ATC and AVC
Shut down immediately, will make more of a loss if you continue operating
What is the difference between external and internal economies of scale
External are any factor which causes a firms LRAC to fall as a result of the industry/market growing in size
What is the MES (minimum efficient scale)
The point on the LRAC where there are the lowest average costs
