Production & Firm Theory

inputs

good or service used to produce output

in the context of a firm, define total revenue

the total a company earns from their quantity sold

total revenue

price multiplied by quantity sold

in the context of a firm, define average revenue

the amount a company earns per unit sold

average revenue

total revenue divided by quantity

if price is constant for all sales, what is average revenue equal to?

price

in the context of a firm, define marginal revenue

the change in total revenue from selling one more or one less unit

marginal revenue

change in total revenue divided by change in quantity

define the short run for a firm

at least one input is fixed (capital such as buildings or machinery) while others (labor) can be varied. firms can increase or decrease their variable inputs to change output. the fixed inputs cannot be changed.

what does the short run for a firm lead to

leads to diminishing returns - as more variable inputs are added the additional output gained from each unit eventually decreases as the other factors remain fixed

define the long run for a firm

all inputs are variable - allows firms to achieve optimal production levels and economies of scale as they can fully adapt to market conditions

define the short run for an industry

the number of firms in the industry is fixed, existing firms can only adjust their output levels. firms may temporarily earn high profits or losses in the short run

why is the number of firms in the market fixed in the short run for an industry?

firms cannot quickly enter or exit the market

define the long run for an industry

firms can enter or exit the market freely, firms in the industry earn a normal profit meaning they cover all their costs

long run for industry - firms making profit

if firms are making profits new firms will enter the market, increasing supply and driving down prices

long run for industry - firms incurring losses

if firms are incurring losses some will exit, reducing supply and allowing prices to rise

economies of scale - specialisation/division of labour

larger companies have a greater opportunity to hire employees for particular tasks - this division of labour can be a more productive use of this input

economies of scale - purchasing

lower averaging costs can result from bulk buying inputs

economies of scale - financial

large firms may be perceived as more creditworthy and receive lower interest rates on financing

economies of scale - technological

larger firms may be better able to take advantage of technological progress - e.g. fracking in the oil industry

diseconomies of scale - organisational diseconomies

larger companies have a greater need for specialised staff - may lead to a need to hire and train new employees which can increase average costs. larger companies are also more vulnerable to communication breakdown and managerial inefficiencies

diseconomies of scale - purchasing diseconomies

larger companies may have larger profit margins meaning they may pay a higher cost for the same inputs increasing average costs

explain why firms face a U shaped average cost curve in the long run (1)

flexibility - all costs and inputs are variable in the long run

explain why firms face a U shaped average cost curve in the long run (2)

economies of scale - if the firm experiences economies of scale (bulk buying so inputs may cost less or specialisation of labour leading to higher productivity) these economies of scale can cause average costs to decrease

explain why firms face a U shaped average cost curve in the long run (3)

downward slope - economies of scale leads to downward sloping segment of the curve

explain why firms face a U shaped average cost curve in the long run (4)

diseconomies of scale - conversely if the firm encounters diseconomies of scale (large firm experiences organisational difficulties from poor management of employees) the curve will slope upward as average cost increases