unit 4 production cost curves and revenue

fixed, variable, total costs

• fixed - costs don’t vary with output

• variable - vary directly with the level of output - output increases more than costs at the start because of underutilised capital - productivity is rising - a further increase in workers means fixed FOP (land, capital) become a constraint on production, workers productivity falls - costs rise (law of diminishing returns)

• total - the sum of fixed and variable costs

average variable and fixed costs

average - total costs divided by output

sunk costs

costs required to start up/run the firm which cant be recovered

marginal and average costs in the short run

• marginal - the cost of producing 1 additional unit of output

• AC = total cost / quantity

• MC = change in TC / change in Q

• in stage 1 there is increasing labour productivity and marginal product because of specialisation and underutilisation of fixed FOP

• in stage 2 the law of diminishing returns kick in as fixed FOP become a constraint on production so labour productivity and marginal product falls

  • marginal cost rise

labour productivity

• measures outpour per worker

• total outpour / units of labour

capital productivity

• measures output per capital

• total output / units of output per capital

specialisation

the concentration of production on a narrow range of goods and services

advantages of specialisation

• higher output - efficient use of resources - trade increases - growth increases - better living standards - more jobs

• wider range of goods and services - within a narrow focus, firms produce a wide range of products

• allocative efficiency - resources go to the firms / country’s that are the most efficient at producing

• higher productivity - workers become more skilled band are used to their maximum productive potential

  • lowers unit cost - passed onto consumers

• quality improvements

issues with specialisation

• finite resources

  • overspecialised firms or country’s can become over reliant on certain resources

  • what if other firms become more efficient at producing that good

• what if fashion or trends change

• de-industrialisation

  • if another firm is more efficient - the other firm will shut down

• national interdependence

  • international issues can block trade and stop the benefits of specialisation

division of labour

the separation of a work process into a number of tasks , with each task preformed by a separate version or worker, allowing for increased efficiency and specialisation

advantages of division of labour

• high productivity

  • workers preform the same task - lower cost of production - lower costs - output maximised - lower prices - high profits

• capital can improve productivity

• lower prices, high quality and choice

problems with division of labour

• preforming the same task can demotivate workers - lower productivity

  • high employee turnover

• workers are at risk of long term unemployment is technology advances

• highly standardised goods and services

short run

at least 1 FOP is fixed

long run

all FOP are variable

law of diminishing returns

• effects firms in the short run

• when variable factors of production are added to a stock of fixed factors of production, total / marginal product will initially rise then fall

• stage 1 - increasing returns to labour - marginal product is rising

  • why, labour productivity is rising

  • specialisation

  • under utilisation of fixed FOP

• stage 2 - law of diminishing marginal returns sets in - marginal product falls

  • why, labour productivity decreases

  • fixed FOP become a constraint on production

    • not enough FOP

• TP is maximised when marginal product is 0

marginal product

change in total product / change in Q of workers

average product

total product / Q of workers

increasing returns to scale

• an increase in all factors of production causes returns (output) to increase proportionally more

• 50% increase in FOP causes a 100% increase in output

constant return to scale

the increase in FOP causes an equal proportional increase in output

decreasing returns to scale

an increase in all factors of production leads to a less than proportional increase in output

LRAC - returns to scale

economies of scale

falling long run average costs as output increases

minimum efficient scale

lowest level of output required to fully exploit economies of scale and the firm achieves productive efficiency

internal economies of scale

• arise from the increased output of the business itself leading to lower avg costs - spread costs over a wider range of output

• financial - banks lend at lower interest rates - less risk

• managerial - as a firm gets larger they can employ specialist managers - increase in productivity - higher output

• technical - specialist machinery boosts productivity

• marketing - discount on advertising - bulk buying

• purchasing - firms can bulk buy as they grow - discount

external economies of scale

• occur within an industry, all firms benefit

• better transport infrastructure

• component suppliers move closer

• R and D firms move closer

agglomeration

the clustering of businesses in a specific area to share resources and benefit from shared infrastructure, leading to lower costs and improved efficiency

diseconomies of scale

an increase in LRAC as output increases - total costs rise faster than output

internal diseconomies of scale

• control - harder to manage - lower productivity

• communication - harder to spread messages through the company - lower productivity

• coordination - difficult to coordinate different parts of the business

• motivation - each worker feels less valued as the business grows reducing motivation and productivity

external diseconomies of scale

• increased demand for raw materials - price rises - costs rise

• local labour becomes scarce - increased demand - wages rise

revenue

income generated from sales of goods or services

average revenue = price per unit

total revenue / output

marginal revenue

the change in revenue from selling one extra unit of output

total revenue

price per unit X quantity

revenue curve in perfect competition

price takers - all units sold at the same price

revenue curve in imperfect competition

• price makers - different prices being charged by the firm

• governed by law of demand

  • high price = low quantity

  • low price = high quantity

• MR twice as steep at AR

  • when a firm drops its price, it drops it price on all units sold not just units sold beforehand, so MR drops faster than AR

• TR is maximised when MR = 0

profit formula

TR - TC (explicit costs and implicit cost (opportunity cost))

supernormal profit

• profit exceeding normal profit, typically occurring when total revenue exceeds total costs, including both explicit and implicit costs

• AR > AC

normal profit

• minimum level of profit required to keep FOP in their current use

• AR = AC

subnormal profit

• profit that is below normal profit, occurring when total revenue is less than total costs, indicating the firm is not covering all opportunity costs and is incurring an economic loss

• AC > AR

economic profit

the difference between total revenue and total costs, including both explicit and implicit costs, indicating the firm's ability to cover all opportunity costs and earn a return on investment

invention

creation of a new idea without it necessarily becoming a commercial reailty

innovation

transforming an invention into commercial reality

create destruction

process by which existing products or services are replaced by new and improved ones, leading to changes in market dynamics and often resulting in the obsolescence of older technologies or business models

methods of production with technological change

• can lead to more capital intensive production

  • machines replacing labour

• can lead to more labour intensive production

  • need to operate capital

technological change

the overall advancement in technology that enhances production efficiency and alters methods of production

technological advancements affect on cost of production

• LRAC fall

• specialist capital can be brought it

• division of labour - increases efficiency and reduces unit costs

• MES takes place at a greater level of output as EOS are being exploited more with improvements in technology

can improvements in technology improve efficiency

• productive - costs of production are lower

• allocative - lower costs passed on as lower prices

• dynamic - innovation

technological improvements effects on market structures

• lower barriers to entry

• number of firms - more if there are lower barriers to entry - more competitive outcomes

  • if barriers increase could lead to a monopoly

• less homogenous goods - more choice

• more knowledge for consumers and producers

MC connection with supply curve

• Profit-Maximizing Rule

  • A competitive firm maximizes profit where P=MC

  • This condition ensures the firm supplies the quantity where its cost of producing the last unit equals the market price

• Shut-Down Condition

  • In the short run, the firm will only supply output if the price is at least as high as average variable cost

  • So, the firm's short-run supply curve is the portion of the MC curve that lies above the AVC curve

• Long-Run Supply

  • In the long run, the firm must cover all costs, including fixed costs. The supply curve becomes the portion of the MC curve that lies above the average total cost (ATC) curve