Business Economics

Production

Production

Converting inputs into outputs with an exchangeable value

Productivity

Output per unit of input employed.

It is a way of measuring how efficiently a company or an economy is producing its output.

Labour productivity

The amount of output produced per worker (or per worker-hour)

Division of labour

A type of specialisation where production is split into different tasks and specific people are allocated to each task.

Adam Smith explained the increase in productivity that could be achieved through division of labour.

Advantages of Specialisation

• People can specialise in what they are best at

• Better quality and higher quanity of products due to increased labour productivity

• Firms can achieve economies of scale

• More efficient production

• Reduced training costs

Disadvantages of Specialisation

• Workers can end up doing repetitive tasks, leading to boredom

• Countries can become less self-sufficient

• Lack of flexibility for workers

Functions of money

• A medium of exchange

• A measure of value

• A store of value

• A standard (or method) of deferred payment

Firm

Any business organisation which generates revenue by selling their output. They use factors of production to produce the output.

Cost of production

The economic cost of producing the output. This includes the money cost of FoPs as well as opportunity cost.

Short run

At least one of a firm’s factors of production is fixed

Long run

All factors of production can be varied

Total Cost (TC)

All the costs involved in producing a particular level of output

TC = TFC + TVC

Average Cost (AC)

Cost per unit produced.

AC = TC / Q

Short Run Average Cost Curve (SRAC)

• Likely to be u-shaped

• AC initially falls as output increases and then starts to increase

• AVC is u-shaped because it is limited by FoPs

• AFC falls as output rises because TFC is spread across greater levels of output

Economies of Scale

The cost advantages of production on a large scale

Technical economies of scale

• Production line methods can be used to make a lot of things at a very low average cost

• Specialised equipment can help reduce average costs

• Workers can specialise - this might not be possible in a small firm

• Law of increased dimensions

Purchasing Economies of Scale

• Large firms will need larger supplies of raw materials so can negotiate discounts with suppliers

• They can get a good bargain because they will be the most important customers of suppliers

Managerial Economies of Scale

• Large firms can employ specialist managers to take care of different areas of the business

• They gain expertise and experience in a specific area of the business, leading to better decision-making abilities in that area

Financial Economies of Scale

Larger firms can often borrow money at a lower rate of interest. Banks also view lending to them as less risky compared with smaller firms.

Risk-bearing Economies of Scale

• Larger firms can diversify into different product areas, leading to a more predictable overall demand

• This makes them more able to take risks, as their other acitivities allow them to absorb the costs of failure more easily

Marketing Economies of Scale

• Advertising is usually a fixed cost which can be spread over more units for larger firms, reducing the cost per unit

• Larger firms also benefit from consumer trust due to brand awareness

External economies of scale

• Local colleges may start to offer qualifications needed by big local employers, reducing training costs

• Improvements in road networks and public transport

• Suppliers may choose to locate in the same area, reducing transport costs

Diseconomies of Scale

Average costs rise as output rises

Internal Diseconomies of Scale

• Waste and loss can increase. Bigger warehouses might lead to more things getting lost

• Communication and coordination may become more difficult

External Diseconomies of Scale

• As a whole industry becomes bigger, the price of raw materials may increase (since demand will be greater)

• Buying large amounts of materials may not make them less expensive per unit, such as when supplies need to be transported long distances

Price Taker

A firm which is a price taker has no power to control the price it sells it. It will have a flat (perfectly elastic) demand curve).

Price Maker

These firms have some power to set the price they sell at. Its demand curve will slope downwards - to increase sales the firm must reduce the price.