Theme 3.3 : Revenue, costs and profits Flashcards
Definition of total revenue
The total amount of money coming into a business through the sale of goods and services (quantity x price)
Definition of average revenue
AR is equal to TOTAL REVENUE/OUTPUT
Revenue that is earned per unit of output
Definition of marginal revenue
Extra revenue that the firm earns from selling one more unit of production
CHANGE IN TOTAL REVENUE/CHANGE IN OUTPUT
Definition of fixed costs
Costs which don’t vary with output
Definition of variable costs
Costs which vary with output
What is marginal cost?
The cost of selling one extra unit
Why do marginal costs decrease and then increase?
Marginal cost initially decreases because as output increases and more workers are hired, they can specialise, increasing productivity and decreasing marginal cost.
But marginal cost will then increase because diminishing marginal returns will decrease productivity, increasing marginal cost.
Write the definition of Diminishing marginal returns (or the law of diminishing marginal returns)
In the short run, as more factors are employed, the marginal returns from these factors will eventually decrease
Write the definition of Internal economies of scale
Internal economies of scale are when long-run average costs fall as a firm’s quantity increases.
6 different types of Economies of scale
-Risk-bearing economies
-Managerial economies
-Financial economies
-Purchasing economies
-Technical economies
-Marketing economies
Definition of Risk-bearing economies
Bigger firms can use their big profits to diversify into new areas, reducing the cost of failure in one sector.
For example, Virgin has diversified into 400 different areas.
Definition of Managerial economies
Bigger firms can afford to hire highly skilled specialist managers, which increases their productivity and decreases their LR average costs
E.g. Amazon hires specialist accounting, software and marketing managers.
Definition of Financial economies economies of scale
Bigger firms are less risky, so they can secure cheaper loans, reducing their long-run average costs.
E.g. Alibaba.com borrowed £3bn at a tiny 2% interest rate.
Definition of Purchasing economies
Bigger firms can bulk-buy and negotiate lower prices, reducing their long-run average costs
E.g. McDonald’s purchases thousands of tonnes of chicken breast at a very low average cost.
Definition of Technical economies
Bigger firms can invest in specialist capital, to increase a firm’s productivity and decrease their long-run average costs.
E.g. Amazon’s warehouse robots and Kameoka’s robot lettuce farmers have massively increased productivity.
Definition of Marketing economies
Bigger firms can spread their marketing costs across many units, decreasing their long-run average costs.
E.g. Guinness, Beats or Nike, who spend millions on marketing in total but just pennies on average, because their costs are so spread out.
What is meant by internal diseconomies of scale
Internal diseconomies of scale lead to a rise in long run average cost, as a firm expands.
Types of internal diseconomies of scale
- Alienation
- Bureaucracy
- Communication
Write the definition of Alienation
Workers feel alienated in very large firms, like they’re just another cog in the machine. This leads to demotivation, decreasing productivity, increase LRAC.
E.g. large call centres in India.
Definition of Bureaucracy
Bureaucracy is all the paperwork, managers, filing and secretaries that a firm has to pay for when it expands, increasing LRAC.
Write the definition of Communication
In big firms, employees may argue with each other and communication will be slow because big firms have so many layers. These factors will reduce productivity, increasing LRAC.
Definition of minimum efficient scale
The point at which a firm first reaches its lowest LRAC
Definition of external economies of scale
When a firm’s LRAC fall due to expansion in the size of the industry
E.g. Silicon valley expanded, attracting new software engineers for lower wages, reducing wages the firms had to pay, reducing LRAC
How do knowledge transfers lead to external economies of scale?
When an industry expands, knowledge will be transferred between firms. This helps firms learn more effective new production techniques, decreasing their LRAC.
E.g. In LA’s film industry, the green screen technique was spread by knowledge transfer. Using green screens has reduced film producers’ long run average costs.
In the short run, why would a firm stay in the market, even if they are making a loss when the price<AVC
Firms will stay in the market so that when they enter the long run they can break even and make supernormal profit
BUT
If in the short run, AR<AVC the firm will leave the market because it is not covering its average variable costs
Outline the short-run shutdown points
Stay in the market when PRICE>AVC
Shut down point when PRICE = AVC
Leave the market when PRICE<AVC
Outline the long-run shutdown points
Stay in the market when PRICE>ATC
Shut down point when PRICE = ATC
Leave the market when PRICE<ATC
What are the 4 types of efficiency
- Productive
- Allocative
- X efficiency
- Dynamic
Definition of productive efficiency
-Productive efficiency is the ability of a firm to produce goods or services at the lowest possible cost, given the level of output and the available technology.
- Where MC = AC
- When average costs are at their lowest
Definition of allocative efficiency
- When welfare is maximised so when MC = price or MC = Demand
Definition of X inefficiency
- The gap between a firm’s cost curve and actual costs
- When for a given level of output, the firm’s costs are above the AC curve
Definition of dynamic efficiency
- When changing technology improves a firm’s output potential over time.
- The firm has to be making supernormal profit so they can invest in research and development
Why does MC decrease then increase?
Marginal cost initially decreases because as output increases and more workers are hired, they can specialise; increasing productivity and decreasing marginal costs
BUT marginal cost will then increase because diminishing marginal returns will decrease productivity, increasing marginal cost
