Revenues, Costs And Profits- Theme 3

Question 1

Formula to calculate total revenue.

Answer 1

Price x quantity

Question 2

Formula to calculate average revenue.

Answer 2

Total revenue / quantity

Question 3

Formula to calculate marginal revenue.

Answer 3

The revenue associated with each additional unit sold ie. The change in total revenue from selling one more unit.

Question 4

Describe price elasticity of demand and its relationship to revenue concepts

Answer 4

On elastic part of the demand curve, if firm lowers prices then total revenue increases and if it raises prices then total revenue falls. On inelastic part of the demand curve, if firm lowers prices then revenue will fall and if firm raises prices then revenue will rise.
PED= %change in QD/ % change in P

Question 5

Define total cost.

Answer 5

These will include all the rewards to the factors of production. Fixed costs+ variable costs.

Question 6

Define fixed costs.

Answer 6

Costs that don’t vary with output. They can apply only when at least 1 factor of production is fixed. This will be the case in the short run only.

Question 7

Define variable costs.

Answer 7

Costs that vary with output, such as raw material consumption in a manufacturing process. Can occur in short term and long run

Question 8

Define average (total) cost.

Answer 8

Average cost per unit of output.

Question 9

Define average fixed cost.

Answer 9

Fixed costs/ output.

Question 10

Define average variable cost.

Answer 10

Variable costs/ output.

Question 11

Define marginal cost.

Answer 11

Change in total costs when one more unit of output is produced

Question 12

Explain deriving the short-run average cost curve.

Answer 12

The average total cost and average variable cost curves slope downwards because of increasing returns to a fixed factor. As greater inputs are added to a fixed factor such as a shop, the firm will increase output at a faster rate therefore AC will fall. However, beyond the lowest point of the AC and AVC, the firm begins to experience diminishing returns to a fixed factor and therefore, as more FOP are added to fixed factor, they start to add less than the last to total output and the AC and AVC start to increase.

Question 13

Explain the relationship between the short-run and long-run average cost curves.

Answer 13

LRAC curve made up of many SRAC curves joined together at their lowest points. In short run firm is constrained by at least one FOP being fixed, while in the long run all FOP are variable, so at end of 1 short-run period the firm will be able to change all of its FOP and in turn enter new short run. All of these short runs make up long run time period.

Question 14

Define internal economies of scale.

Answer 14

Falling long-run average costs associated with an increase in output for an individual firm.

Question 15

Define external economies of scale.

Answer 15

occur when a whole industry grows larger and firms benefit from lower long-run average costs.

Question 16

Define financial economies of scale.

Answer 16

As a firm grows, it is better able to access loans at low cost. Banks will be more willing to lend as there’s less risk associated with the transaction.

Question 17

Define risk-bearing economies of scale.

Answer 17

As firm expands, its better able to develop a range of products and a wider customer base to spread risk and minimise impact of any downturn.

Question 18

Define marketing economies of scale.

Answer 18

As firm expands its product range, it’s able to use any central brand marketing to advertise the range at little extra cost and therefore spread this across a wider range of goods and decrease LRAC.

Question 19

Define managerial economies of scale.

Answer 19

As firm expands, it’s in position to employ specialist managers in finance, sales or operations and therefore increase productivity and decrease long-run average costs.

Question 20

Define diseconomies of scale.

Answer 20

An increase in long-run average costs as output increases. Often associated with managerial difficulties.

Question 21

What is the minimum efficient scale?

Answer 21

In some cases a firm might have already exploited economies of scale and be operating at the most productively efficient point: that it, the optimum efficiency might have been achieved. Any further increase would result in inefficiencies and in an increase in AC.

Question 22

Explain profit maximisation.

Answer 22

Occurs at output level where supernormal profits are at their greatest. This occurs where MC = MR, this is necessary condition it’s not sufficient. MC must also be rising.

Question 23

Define normal profit.

Answer 23

Normal profit is the transfer earnings of the entrepreneur. The activities of the entrepreneur are independent of the level of output. Normal profit is therefore a fixed cost, included in the average, not the marginal, cost curve

Question 24

Define supernormal profit.

Answer 24

A firm earns supernormal profit when its profit is above that required to keep its resources in their present use in the long run i.e. when price > average cost

Question 25

Define losses (sub-normal profits).

Answer 25

Any profit less than normal profit – where price < average cost

Question 26

Explain short-run and long-run shutdown points.

Answer 26

Shutdown point for firms occurs when the firm is not covering AVC. It may be feasible for a firm to make a loss in the short run, as long as it covers the variable cost of making the good and therefore makes a contribution to the fixed costs.