Theme 3.3 : Revenue, costs and profits

Question 1

Definition of total revenue

Answer 1

The total amount of money coming into a business through the sale of goods and services (quantity x price)

Question 2

Definition of average revenue

Answer 2

Demand is equal to TOTAL REVENUE/OUTPUT

Question 3

Definition of marginal revenue

Answer 3

Extra revenue that the firm earns from selling one more unit of production

CHANGE IN TOTAL REVENUE/CHANGE IN OUTPUT

Question 4

Definition of fixed costs

Answer 4

Costs which don’t vary with output

Question 5

Definition of variable costs

Answer 5

Costs which vary with output

Question 6

What is marginal cost?

Answer 6

The cost of selling one extra unit

Question 7

Why do marginal costs decrease and then increase?

Answer 7

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.

Question 8

Write the definition of Diminishing marginal returns (or the law of diminishing marginal returns)

Answer 8

In the short run, as more factors are employed, the marginal returns from these factors will eventually decrease

Question 9

Write the definition of Internal economies of scale

Answer 9

Internal economies of scale are when long-run average costs fall as a firm’s quantity increases.

Question 10

6 different types of Economies of scale

Answer 10

-Risk-bearing economies
-Managerial economies
-Financial economies
-Purchasing economies
-Technical economies
-Marketing economies

Question 11

Definition of Risk-bearing economies

Answer 11

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.

Question 12

Definition of Managerial economies

Answer 12

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.

Question 13

Definition of: Financial economies

Answer 13

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.

Question 14

Definition of Purchasing economies

Answer 14

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.

Question 15

Definition of Technical economies

Answer 15

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.

Question 16

Definition of Marketing economies

Answer 16

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.

Question 17

What is meant by internal diseconomies of scale

Answer 17

Internal diseconomies of scale lead to a rise in long run average cost, as a firm expands.

Question 18

Types of internal diseconomies of scale

Answer 18

• Alienation
• Bureaucracy
• Communication

Question 19

Write the definition of Alienation

Answer 19

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.

Question 20

Write the definition of Bureaucracy

Answer 20

Bureaucracy is all the paperwork, managers, filing and secretaries that a firm has to pay for when it expands, increasing LRAC.

Question 21

Write the definition of Communication

Answer 21

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.

Question 22

Definition of minimum efficient scale

Answer 22

The point at which a firm first reaches its lowest LRAC

Question 23

Definition of external economies of scale

Answer 23

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

Question 24

How do knowledge transfers lead to external economies of scale?

Answer 24

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.

Question 25

In the short run, why would a firm stay in the market, even if they are making a loss when the price<AVC

Answer 25

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

Question 26

Outline the short-run shutdown points

Answer 26

Stay in the market when PRICE>AVC
Shut down point when PRICE = AVC
Leave the market when PRICE<AVC

Question 27

Outline the long-run shutdown points

Answer 27

Stay in the market when PRICE>ATC
Shut down point when PRICE = ATC
Leave the market when PRICE<ATC

Question 28

What are the 4 types of efficiency

Answer 28

• Productive
• Allocative
• X efficiency
• Dynamic

Question 29

Definition of productive efficiency

Answer 29

• Where MC = AC
• When average costs are at their lowest

Question 30

Definition of allocative efficiency

Answer 30

• When welfare is maximised so when MC = price or MC = Demand

Question 31

Definition of X inefficiency

Answer 31

• 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

Question 32

Definition of dynamic efficiency

Answer 32

• 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

Question 33

Why does MC decrease then increase?

Answer 33

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