Topic 3: Revenues, Costs and Profits

Question 1

How do you calculate total revenue?

Answer 1

Price x quantity sold

Question 2

Marginal revenue

Answer 2

The extra revenue a firm earns from the sale of one extra unit. When marginal revenue us 0, total revenue is maximised.

Question 3

Where on a diagram is marginal revenue shown?

Answer 3

MR = 0 on the revenue diagram directly below the midpoint of the AR curve.

Question 4

Average revenue

Answer 4

The average receipt per unit. TR / quantity sold AKA The price each unit is sold for.

Question 5

What does the AR curve look like in markets when firms are price takers?

Answer 5

The AR curve is horizontal as this shows the perfectly elastic demand for their goods. As the demand curve shows the relationship between price and quantity. Average revenue = marginal revenue.

Question 6

What does the AR curve look like in markets when firms are price makers?

Answer 6

The AR curve us downward sloping.

Question 7

How do you calculate total cost?

Answer 7

Total costs = Total variable costs + total fixed costs

Question 8

How do you calculate total fixed costs

Answer 8

Fixed costs do not vary with output

Question 9

How do you calculate average total costs

Answer 9

total costs / quantity produced

Question 10

How do you calculate average fixed costs

Answer 10

total fixed costs / quantity

Question 11

How do you calculate average variable costs

Answer 11

total variable costs / quantity

Question 12

Marginal costs

Answer 12

How much it costs to produce one extra unit.
Change in TC / Change in Quantity

Question 13

The law of diminishing marginal productivity

Answer 13

• Adding more units of a variable input to a fixed input, increases output at first.
• However, after a certain number of inputs are added, the marginal increase of output becomes constant.
• Then, when there is an even greater input, the marginal increase in output starts to fall.

Question 14

Draw what happens on a cost revenue diagram with diminishing returns

Answer 14

• MC, ATC and AVC rise with diminishing returns.
• AFC falls with increasing output.

The Lowest points (the yellow highlighted circles) are the points where diminishing marginal productivity sets in. Before this AC are falling and after this AC are rising.

Question 15

Draw a diagram to show the relationship between Short run and long run average cost curves.

Answer 15

• The lowest point is the minimum efficient scale. This is where the optimum level of output is since costs are lowest.

Question 16

Show the relationship between SRAC curve and the LRAC curve on a diagram

Answer 16

The LRAC curve envelopes the SRAC curve, and it is always equal to or below the SRAC curve. The LRAC curve shifts when there are external economies of scale, i.e. when an industry grows.

Question 17

What are the 6 different types of internal economies of scale?

(RFMTMP)

Answer 17

1. Risk-bearing
2. Financial
3. Managerial
4. Technological
5. Marketing
6. Purchasing

Question 18

External economies of scale

Answer 18

These occur within an industry when it gets larger. Eg local roads might be improved, so transport costs for the local industries will also fall. Also there might be more training facilities or more research and development, which will also lower average costs for firms in the local area.

Question 19

What are the 3 types of diseconomies of scale?

Answer 19

Control- becomes harder to monitor how productive the workforce is, as the firm becomes larger.

Coordination- It is harder and complicated to coordinate every worker, when there are thousands of employees.

Communication- Workers may start to feel alienated and excluded as the firm grows. This could lead to falls in productivity and increases in average costs, as they lose their motivation.

Question 20

Normal profit

Answer 20

The minimum reward required to keep entrepreneurs supplying their enterprise in the long run. It covers the opportunity cost of investing funds in the the firm and not elsewhere.

Question 21

Supernormal profits

Answer 21

The profit above normal profits. This exceeds the value of opportunity cost of investing funds into the firm. When TR > TC

Question 22

Losses

Answer 22

A firm makes a loss when they fail to cover their total costs.

Question 23

When might a firm choose to continue operating in the short run?

Answer 23

P > AVC

Question 24

What is the short run shut down price?

Answer 24

When variable costs cannot be covered. This is at the lowest point of the AVC curve. P < AVC.

Question 25

What is the long run shut down price?

Answer 25

TR < TC

Question 26

Draw a diagram to illustrate when a firm would shut down in the short run

Answer 26

• This diagram shows how the revenue curves lie below the cost curves.
• Therefore, P < C. The rectangle formed shows the area of loss.
• At a price of P and an output of Q, the firm would shut down in the short run.