Revision Flashcards
Law of diminishing returns
A short-term law which states that as a variable factor of production is added to a fixed factor of production, eventually both the marginal and average returns to the variable factor will begin to fall.
Marginal returns of labour Definition
The change in quantity of total output resulting from the employment of one more worker, holding all the other factors of production fixed.
Average returns of labour equation
Total output/ total number of workers employed
Total returns of labour Definition
Total output produced by all the workers employed by a firm.
Marginal Cost Definition
The addition to total cost resulting from producing one additional unit of output.
Increasing returns to scale Definition
When the scale of all the factors of production increases, output increases at a faster rate.
Constant returns to scale Definition
When the scale of all factors of production increases, output increases at the same rate.
Decreasing returns to scale Definition
When the scale of all factors of production increases, output increases at a slower rate.
Internal economies of scale U shaped LRAC curve and optimum firm size
Each SRATC represents a particular firm whose size and capacity is fixed in the short-run. In the long-run a firm can move from one short-run cost curve to another. The optimum size is found at the lowest point on the firms LRAC curve, which occurs after economies of scale has been gained, but before diseconomies of scale sets in. The optimum firm size is the size of firm capable of producing at the lowest average cost and thus being productively efficient.
Internal economies of scale horizontal LRAC curve
This LRAC curve has a horizontal section between the economies and diseconomies of scale. It isn’t possible to identify a single optimum firm size. LRAC of production would be the same for any size of firm producing at the lowest point.
Internal economies of scale L shaped LRAC curve and minimum efficient scale
The minimum efficient scale is the lowest output at which firms are able to produce at the minimum achievable LRAC. Here the firm has benefited to the full from economies of scale and average costs are minimised.
Internal economies of scale constant LRAC curve
This curve represents an industry or market in which firms neither benefit from economies of scale nor suffer consequences of diseconomies of scale.
Internal economies of scale LRAC curve in an industry with economies of small scale production
Firms such as hairdressers and personal trainers are seen as small common firms. The market in which these services are provided typically possess economies of small scale production. Diseconomies of scale may set in earlier, resulting in an LRAC curve in which the optimum sized firm is relatively small.
External economies of scale natural monopoly curve
The vertical line shows the maximum size of the market, used to explain natural monopoly. Natural monopolies occur where there is room in a market for only one firm to benefit fully from economies of scale.
External economies of scale constant LRAC curve
Illustrates a market in which large, medium and small sized firms can coexist and compete against one another. No firm can gain a cost advantage or suffer a cost disadvantage.
External economies of scale LRAC curve in an industry with economies of large scale production
The LRAC curve is skewed to the right of the diagram, showing economies of large scale production. Diseconomies of scale eventually set in, but only after substantial economies of scale have been achieved.
Long-run marginal costs Definition
The addition to total costs resulting from producing one additional unit of output when all the factors of production are variable.
Average revenue equation
Total revenue/ quantity
Marginal revenue equation
Change in total revenue/ change in quantity
The roles of profit in a market economy
The creation of business incentives, creation of worker incentives, creation of shareholder incentives, profits and resource allocation, reward for innovation and risk taking, source of business finance, signal of the health of the economy.
The creation of business incentives
Traditional microeconomic theory assumes that profit maximisation is the most important business objective. Rising profits and hope of higher profits provide incentive for managers within firms to work harder to make the business even more profitable. When barriers to entry are low abnormal profits will incentivise new firms into the market which will lead to increased market supply, economic efficiency and economic welfare. However if barriers to entry are high abnormal profits act as a reward for inefficient producers.
The creation of worker incentives
Some companies use profit/ performance related pay to increase worker motivation, in hope that they will work harder and share the objectives of the business’ managers and owners. Can be counter productive as workers may be disincentivised as people higher up get more bonuses.
The creation of shareholder incentives
High profit usually leads to high dividends or distributed profit being handed out to shareholders. Creates more incentive for people to buy shares in the company, this causes the company’s share prices to rise. This makes it cheaper and easier for a business to raise finance.
Profits and resource allocation
High profits made by incumbent firms in a market create incentives for new producers to enter the market and existing firms to supply more of a goof or service. Likewise a failure to make abnormal profits create incentives for firms to leave markets and deploy their resources in more profitable markets.
Profit as a reward for innovation and risk taking
Higher profit allows firms to spend more on R&D, this can lead to better tech, lower costs and dynamic efficiency. Profits very important for some firms which require significant risky investment to develop. Without this profit and investment the economy will stagnate and lose international competitiveness leading to job losses in some sectors.
Profit as a source of business finance
Instead of being distributed to the business’ owners as a form of income, profit can be retained for the business. Retained profits are the most important source of finance for firms undertaking investment projects.
Profit sends out a signal about the health of the economy
The profit made by businesses throughout the economy can send out an important signal about the health of the economy. Rising profits may reflect improvements in supply-side performance. Higher profits also increase tax revenue for the government which can be spent ion the public sector.
Normal Profit Definition
The minimum profit an incumbent firm must make to stay in business, insufficient to attract new firms to the market. Normal profit varies in each industry, depending on the risks facing firms.
Supernormal Profit(abnormal profit) Definition
Extra profit over and above normal profit. In the long-run, and in the absence of barriers to entry, supernormal profit will attract new firms into the market.
Disruptive Innovation Definition
An innovation that helps create a new market, but in doing so disrupts an existing market and displaces earlier technology. A new good or service is created for a different set of consumers in a new market, it eventually lowers the price in the existing market.
