revenue costs and profits 3.3

Total costs

• the overall costs of production incurred by firms when producing a certain level of output

• fixed costs + variable costs

total fixed costs

• costs that do not change with output

• e.g rent and salaries

total variable cost

• costs that change with output 

• e.g raw materials, electricity, wages

• variable cost X quantity

average total cost

• cost per unit

• ATC=TC/Q

• AFC+AVC​

Average fixed costs

• fixed cost per unit of output

• Falls as output rises

• TFC/Q

Average variable cost

• variable cost per unit of output

• TVC/Q

Marginal cost

• The extra cost of producing one more unit of output

• typically falls at first (due to increasing returns) the rises (law of diminishing returns)

• Change in TC/ Change in QUANTITY

Short run

• at least one factor of production is fixed

long run

• all factors of production are variable

• firms can plan for increased capacity and production

marginal product of labour

the change in output that results from adding an additional unit of labour

law of deminishing marginal returns

• when additional units of variable factors of production are added to a fixed factor

• marginal output (output per worker) will eventually decrease

MP diagram 

In the short run, marginal product (MP) increases with the addition of three workers before diminishing returns for each additional worker begin

diagram analysis

• A small food van selling burgers (product) at a music festival increases productivity up to the addition of a third worker

• After that, workers get in each other's way and there is not enough grill space (capital) so MP no longer increases

• If more workers are hired, then the MP of each additional worker begins to fall

• Adding additional workers up to the 7th worker will keep increasing the total product

• With the hiring of the 7th worker, the MP turns negative, which will decrease the total product

connection between DMR and the cost curves

• As the marginal product increases, marginal costs decrease

• - increasing returns= decreasing costs

• decreasing returns= increasing costs

cost curve

Marginal costs fall as long as there are increasing marginal returns

Diagram analysis

• The distance between the AVC and AC = the AFC

  • AVC converges towards AC as the AFC continuously decreases with an increase in output

  • AVC decreases as additional workers are added and each worker produces additional product

• Marginal costs (MC) decrease initially as additional workers are added and the marginal product is increasing

• Diminishing returns begin when the MC starts to increase

• MC will cross the AVC and AC curves at their lowest point

  • As long as the cost of producing the next unit (MC) is lower than the average, it will pull down the average

  • When the cost of producing the next unit (MC) is higher than the average, it will pull up the average

LRAC curve

is the line of best fit between the lowest points of the short-run ATC curves

• In the long-run, they are able to plan to increase the scale of production

Total revenue

The total value of all sales a firm incurs

• PxQ

Marginal revenue

The extra revenue received from the sale of an additional unit of output

change in TR/ change in Q

price taker

Firms that have no market power and are unable to influence price- they take the ‘going price’ offered by the market

economies of scale

long run average costs decrease

• firms enjoy increasing returns to scale- Occurs when an increase in sales leads to a larger then proportional increase in output

decreasing returns to scale

Occurs when an increase in the qty of inputs leads to a less than proportional increase in the qty of output

types of economies of scale

• Financial economies- lower interest rates on loans

• Managerial Economies- large firms can employ specialist managers

• Purchasing economies- when large firms bulk buy raw materials which lower AC

Types of diseconomies of scale

• management diseconomies- managers work in self interest rather than interest of firm

• communcation diseconomies- when a firm has multiple layer of management in different locations slow responses, increases AC

• Geographical diseconomies- when a firm has widespread bases of operations

minimum efficient scale

The lowest cost point on a LRAC curve

• it represents the lower possible cost per unit that a firm in the industry can achieve in the long run

Internal economies of scale

Occurs as a result of the growth in the sale of production within the firm

external economies of scale

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

• The firm is able to benefit from lower LRATC generated by factors outside of the firm

conditions for profit maximisation

MC=MR

profit

TR- TC

Normal profit

TR = TC

Supernormal profit

TR > TC

SR shut down point

• In the short-run, if the selling price (average revenue) is higher than the average variable cost (AVC), the firm should keep producing (AR > AVC)

  • If the selling price (AR) falls to the AVC it should shut down (AR = AVC)

• The firm produces at the profit maximisation level of output (Q) where MC=MR

• At this level, the P = AVC

  • This means that there is no contribution towards the firm's fixed costs

    • The selling price literally only covers the cost of the raw materials used in production

    • There is no point in continuing production and the firm should shut down

LR shut down point

• In the long-run, if the selling price (AR) is higher than the average cost (AC) the firm should remain open (AR > AC)

  • if the selling price (AR) is equal to or lower than the average cost (AC), the firm should shut down (AR = AC)

• The firm produces at the profit maximisation level of output (Q) where MC=MR

• At this level, P < AC

  • It could continue operating in the short-run as the AR > AVC, but in the long-run they are making a loss and the firm will shut down