Theme 3 CC1 - Background to theory of the firm Flashcards
Define the Short run
A Period of time where at least one factor of production is fixed
Define LR
A period of time where all factors of production are variable
Define productivity
Output per unit of input
Explain marginal product
The additional output produced by an additional unit of input
What causes increasing marginal returns if a second worker is employed?
Specialisation - can divide up work; capacity is better utilised
What causes DMR?
Fixed units become a constraint on production e.g. more workers too many people - get in each other’s way or waiting for capital
When does DMR occur on a graph?
Max point of MP
What is the Law of diminishing Marginal returns?
In the SR, when variable factors of production are added to a stock of fixed factors of production, total/marginal product will initially rise and then fall.
How is Average product calculated?
TP/L
How is MP calculated?
🔺TP/🔺L
What is the most commonly fixed Factor of production?
Most common variable input?
Land, capital
Labour
Define fixed costs
Costs which do not vary as the level of production increases or decreases
Define variable costs
Costs which vary directly in proportion to the level of output of a firm
Define semi-variable costs
Costs that vary with output but not in direct proportion i.e. they have both fixed and variable elements
Define Total cost and give equation
The cost of producing any given level of output
TC= TVC + TFC
Why is the TVC curve the shape it is?
Due to DMR, initially increasing marginal returns (specialisation - low costs) then DMR as gradient rises
Define Average cost and give equation
The average cost of production per unit
ATC/AC= TC/Q
How is Average variable cost and Average fixed cost calculated?
AVC=TVC/Q
AFC=TFC/Q
Define Marginal cost and give equation
The cost of producing an extra unit of output or the change in total cost divided by the change in output
MC=🔺TC/🔺Q=TCn - TCn-1
Define Economies of Scale
A fall in the long run average costs of production as output rises.
What is constant returns to scale?
Occur when a firm experiences (minimum) constant LRAC as output increases.
What is minimum efficient scale of production?
The lowest level of output at which LRAC is minimised e.g. start of constant returns to scale (plateau).
Define diseconomies of scale
A rise in the LRAC of production as output rises
What is internal economies of scale?
A fall in LRAC of production as output rises within a firm, due to advantages internal to the firm.
Give acronym and sources of internal economies of scale
Really Fun Mums Try Making Pies
Risk-bearing EOS
Financial EOS
Managerial EOS
Technical EOS
Marketing EOS
Purchasing EOS
Explain Risk-bearing EOS
Larger firms able to diversify into more products/markets, reducing risk of collapse and risk to investors.
Explain Financial EOS
Larger firms considered more credit worthy, easier access to funds e.g. banks charge lower interest rates.
Explain Managerial EOS
Specialist managers (division of labour) using specialist equipment
Explain Technical EOS
a) Large scale business can afford to invest in specialist machinery
b) Specialisation of workforce to increase productivity.
c) Container principle - Increase height/width of a tanker/building leads to more than proportionate increase in cubic capacity. In transport, revenue from shipments>cost of increase in capacity.
Explain Marketing EOS
Large firms more able to afford larger, more effective advertising campaigns.
Explain Purchasing EOS
Large firms able to ‘bulk buy’ and therefore negotiate lower unit costs.
Define Internal Diseconomies of scale
A rise in LRAC of production as a firm expands beyond its optimum size
Give sources of Internal diseconomies of scale with way to remember
The 4 C’s
Control
Co-ordination
Co-operation
Communication
Explain control as a source of internal diseconomies of scale
Difficult to monitor productivity & quality of output of thousands of employees
Explain co-ordination as a source of internal diseconomies of scale
Difficult to co-ordinate complicated production processes across many factories in different locations & countries, and contracts with suppliers.
Explain co-operation as a source of internal diseconomies of scale
Workers may lack motivation, not feeling important in big organization, therefore productivity may fall.
Explain communication as a source of internal diseconomies of scale
Difficulties between large business - leading to poor decision making and higher costs.
Give 3 ways to avoid diseconomies of scale
- Developments in human resource management e.g. monitor workers, training, promotion, general support of staff.
- Incentives for workers leading to higher productivity e.g. performance-related pay schemes
- Outsourcing of manufacturing and distribution can help a business to supply ever-distant markets, reducing costs whilst retaining control over production.
Define External economies of scale
Falling average costs of production, shown by downwards shift in LRAC curve, which results from a growth in the size of the industry within which a firm operates.
Give 3 industry changes external economies of scale lead to?
- Better local transport network
- Lower training costs: pool of skilled workers
- Research and development facilities in local universities
- Component suppliers and other support businesses in the area.
Define external diseconomies of scale
Rising average costs of production, shown by an upward shift in the LRAC curve, which results from a growth in the size of the industry beyond its optimal size.
Define revenue and give equation
The income a firm recieves from selling its output
TR= PXQ=ARXQ
Give equation for average revenue and identify the curve
AR=TR/Q=(PXQ)/Q=P
Known as the Demand curve
Define marginal revenue and give equation
The additional revenue from selling an additional unit of output
MR=🔺TR/🔺Q
What is a price taker compared to a price maker?
How can each be identified?
- A price taker is a firm which has no influence on the market price and must sell all its output at market price. Identified by TR curve as a straight line
- A price maker is a firm which is able to select the price at which it sells its output. Identified by TR curve as a parabola.
When does a firm maximise total revenue?
When MR=0
What is the relationship between AR and MR curve?
MR is twice as steep as AR
How is profit worked out?
Profit (Π) = Total Revenue-Total Costs
What are financial costs?
Costs actually paid out but by the firm e.g. rent, wages, raw materials
Define normal profit
The profit that the firm could make by using its resources in their next best use (opportunity cost). Referred to as ‘break-even’ where TR=TC
How is economic cost worked out?
Financial cost+ normal profit
What is subnormal vs supernormal profit
Subnormal - Profit (‘losses’) occur when TC>TR
Supernormal - Profit (abnormal or economic profit) above normal profit e.g. TR>TC
How do accountants and economists work differently?
Accountants just look at explicit (Financial costs) whereas economists look at implicit costs also (e.g. opportunity cost)
How can we work out marginal profit?
MR-MC
When is profit maximised?
Where MR=MC,
At the largest gap of TR-TC
What are the functions of profit?
- Profit is the return of the entrepreneur for risk-taking.
- Dividends are paid out to shareholders to encourage them to hold shares. Fall in profit will cause shareholders to sell share.
- Measure of success of business and a comparison between businesses.
- Profit acts as a market signal
Why is AR curve downward sloping for price makers?
AR= Demand curve, in monopolist industry therefore demand is downward sloping.
- Trade off between price and Quantity sold.
Price maker - Why is MR downward sloping and below AR curve?
Firms must reduce price to sell more units
As price falls demand increases
