3.3- revenue, costs and profits

def short run

A period of time where there is at least 1 fixed factor of production

explain law of diminishing returns

in the short run, when variable factors of production are added to a stock of fixed factors of production (e.g: land + capital) , total/marginal product will initially rise and then fall

reasons for AP + MP curve

1. adding labour → initially: more specialisation + unused capacity being utilised → output per worker rises → MP rises

2.eventually: fixed factors utilised→ workers have to share capital → output per worker falls → MP falls

def long run

all factors of production are variable

what is an implicit cost?

the opportunity cost - the profit they could have made doing their next best alternative

def fixed cost + example

costs that do not vary directly with level of output

e.g = rent , salaries,

def variable costs

costs that do vary with output

e.g = wages of employees paid by the hour, cost of electricity + gas (utility bills)

def marginal cost

the cost of producing one additional unit of output

def average cost

total cost divided by quantity produced

formulae for AC

TC / Q

formulae for MC

/_\TC divided by /_\Q

why does the MC have its shape?

• slopes down at first = increasing labour productivity→ increasing MP (due to specialisation + underutilisation of fixed factors of production) → the increase of MP decreases MC

  • labour productivity decreases, MP decreases → due to fixed factors of production becoming a constraint on production → MC will rise

def MES

minimum efficient scale

• lowest level of output required to exploit full economies of scale

def revenue

the money made from sales by a business

def diseconomies of scale

rise in LRAC as output increases

def economies of scale

a reduction in LRAC as output increases

def internal EoS

occurs inside the firm that are controllable

def managerial economies

as a firm gets larger they can hire specialist managers

• the managers can monitor + boost worker productivity

• productivity rising faster than cost → brings down AC

def technical economies

bringing in specialist machinery as a firm gets larger → boosts productivity

costs will rise but productivity will rise faster causing AC to fall

def purchasing economies

buying raw materials in bulk → allowing unit discounts to be negotiated

costs are rising slower than output is rising→ falling costs

def risk bearing (type of internal Eos)

as a firm gets larger, they can spread their risk over a larger output range

def financial EoS

firms can negotiate lower interest rates with a bank

def marketing EoS

companies can bulk buy advertising → they can negotiate better unit rates of advertising

AC is rising slower than output is rising → AC falling

def external EoS

occurs outside the firm but within the industry

(firms benefit without direct control)

what are the 3 types of external EoS

better transport infrastructure - reduces costs as a business, cheaper to sell goods + access raw materials → lower AC

Component suppliers move closer - its in their interest to be close to a huge firm → cuts down transportation costs of raw materials

R + D firms can move closer - the firm can use this + improve technology → reducing costs

def diseconomies of scale

an increase in LRAC as output increases

what are the problems of firms getting to big (diseconomies)

control = as a buisness gets larger it becomes much more difficult for managers to control the workforce → TC rises faster than quantity (output)

Communication + coordination = coordinating different parts of the buisness becomes more difficult → harder for different departments to work together…

Motivation = workers feel less valued in a huge firm → They are replaceable

def normal profit

min level of profit required to keep factors of production in their current use (AR = AC)d

def supernormal profit

any profit above normal profit (AR > AC)

def subnormal profit

any profit below normal profit (AR < AC)

give examples of fixed costs

rent

salaries

machinery (capital costs)

give examples of variable costs

raw materials

wages of employees paid by the hour

utility bills (electricity + gas)

def fixed costs

costs that don’t vary directly with output

def variable costs

costs that vary directly with output

How does increased variable costs affect AC + MC curves

AC + MC shift upwards

how does decrease fixed costs affect AC curve

AC shifts downw

where is profit maximisation point

MC = MR