3.3 revenues, costs and profits

definition of economic long run

when all factors of production are variable

definition of economic short run

when at least one factor of production is fixed

what is the law of diminishing marginal productivity

if a variable FoP is added to a fixed FoP, eventually productivity will start to decrease

what is average product 

output per unit of input 

what is marginal product

additional output produced by an additional unit of input

what are fixed costs + examples

costs that don’t change with output e.g. salaries, factory machinery

what are sunk costs

costs that can’t be recuperated when businesses leave the market (part of fixed costs)  e.g. advertising

what are variable costs 

costs that vary with output e.g. wages, raw materials 

total cost formula

total fixed cost + total variable cost

total variable cost formula

average variable cost x output (Q)

average total cost formula

total cost / output

average fixed cost formula 

total fixed cost / output 

average variable cost

total variable cost / output

marginal cost formula

change in total cost / change in output

difference between economists and accountants

economics take opportunity costs into account

what is total revenue 

price x quantity 

average revenue formula

total revenue / output

marginal revenue definition and formula

extra revenue received from the sales of an additional unit of output

change in TR / change in Q

relationship between total revenue and PED 

• when PED elastic if there is a decrease in price TR will increase

• if PED inelastic if there is a decrease in P TR will decrease

representation of where diminishing marginal returns begin on a graph

diagram of relationship between short run and long run average cost curves

types of economies of scale

• financial economies - lower IR for larger firms

• managerial economies - larger firms can employ specialist managers = effeciency

• marketing economies - larger firms spread costs of advertising on large number of sales

• purchasing economies - bulk discounts on raw materials

• technical economies - spread costs of new machinery over more units sold = lower AC

• risk-bearing economies - spread risk of failure through diversification

types of diseconomies of scale 

• management diseconomies - managers work in own interest not the firms 

• communication diseconomies - inefficient communication 

• geographical diseconomies - communication challenges in widespread operation bases 

• cultural diseconomies - culture clash in the workplace = decreased productivity 

what is the minimum efficient scale

lowest cost point on a long run average total cost curve

lowest possible cost per unit that a firm in an industry can achieve in the long run

minimum efficient scale on a diagram

what are internal economies of scale

result of the growth in the scale of production within a firm

what are external economies of scale 

when there is an increase in the size of an industry in which the firm operates 

what are examples of external economies of scale

• geographic cluster - firms move closer to major manufacturers

• transport links - lowers LRAC

• skilled labour - lower labour costs - larger geographic cluster = larger pool of skilled labour

• fabourable legislation - when govs support certain industries to achieve their wider objectives

what is the profit maximisation point

MC=MR

what are explicit costs

costs which have to be payed e.g. wages and raw materials

what are implicit costs

opportunity costs

need to be considered when deciding if more profit can be made elsewhere

profit formula

total revenue - total costs

normal profit

• TR = TC (breakeven)

• just enough to cover costs 

when do supernormal profits occur

when TR>TC

when do losses occur

when TC>TR

when should firms shut down in the short run (SR shut-down profit) 

if AR is higher than AVC the firm should keep producing

the firm should shut down if selling price (P/AR) doesn’t cover AC (e.g. in diagram)

when should firms shut down in the long run (long-run shut-down profit) 

• if LRAR is higher than LRAC 

• if AR is less than or equal to AC the firm should shut down