Production, costs and revenue

What is production?

• Converts inputs into outputs of goods/services

What is short run production?

• When a firm adds variable factors of production to fixed factors of production

• E.g. Employing more labour

What is long run production?

• When the firm changes the scale of all factors of production

Define productivity

• Output per unit input

• We can measure labour and capital productivity

What is a productivity gap?

• Difference between labour productivity in the UK and other developed economies

What fundamental economic principle did Adam Smith establish?

• Output could be increased if workers specialise at different tasks in the manufacturing process

• He used a pin factory example

Define specialisation

• When a worker becomes skilled at one task as a result of repetitively preforming it

Define division of labour

• Different workers are assigned to perform different tasks

3 reasons why specialisation increases output

• Workers will not switch between tasks- saving time

• Workers become more efficient or productive at the task they specialise in. Due to the extensive amount of time spent on the task

• Better capital can be employed as specialisation increases efficiency and sales so firms can afford to purchase more machinery,

What are the negative implication of speacialisation?

• Workers get bored of the repetition

• Division of labour can create alienation

• De-skilling in other skills that could be necessary in the future

Why is trade and exchange important?

• Larger markets can be accessed

• A country can use trade to get products they don’t specialise in

• Money is what helps make these exchanges

What are fixed costs?

• Costs of production

• That do not vary with output

What are variable costs?

• Production costs

• They do vary with output

Formula for total costs

FC+VC

Formula for average costs

• Total costs/Output

Explain average cost curve

• Firms average costs of production initially fall as the six of output increases

• Costs are spread over output

• Point x/c is where the firm produces at the lowest possible cost per unit

• This is the most productively efficient level of output

• Beyond this point AC begin to rise

• This is because as a firm expands production, it becomes harder to mange causing a lack of coordination

• Or more expensive inputs are required to maintain production

Define productively efficient level of output

• The level of output at which average costs are minimised

Another formula for average costs

• AC= AFC+AVC

Explain the average fixed cost curve

• If fixed costs are £1000 and a firm only produces one unit the average fixed costs are £1000

• But if a firm increases output average fixed costs decrease

• AFC will never be 0 as there will always be a fixed cost when producing something

• Even if output is heavily increases the fixed cost will remain £1000

Explain the average variable cost curve

• Initially production increases- with the employment of variable factors of production like labour and raw material to fixed inputs

• Average variable costs more spread out over output

• But after a certain point diminishing marginal returns sets in-After a while each additional unit of variable input contributes less to output. Causing marginal returns (extra output) to fall

• As addition of variable inputs becomes unmanageable and less efficient

Explain the difference between LRAC curve and SRAC curve

• Both are U- shaped but the reasoning behind it is different

• SRAC curve assumes labour becomes more productive as it is added to fixed capital before eventually becoming less productive

• LRAC curve is explained by economies and diseconomies of scale.2 concepts that dont operate in the short run

Define economies of scale

• Falling long run average costs of production that result from an increase in the size of the firm

Define diseconomies of scale

• An increase in long run average costs of production that result from the increase in the size of the firm

Define technical economies of scale

• A reduction in average costs generated through changes in the productive process such as

• Indivisibilities-Larger firms can afford high tech machinery that smaller firms cannot, leading to greater efficiency

• Volume economies-Increasing the size of storage, means firms can store more goods at a lower cost per unit as volume increases faster than surface area

Why are indivisibilities disadvantageous for smaller firms?

• Some machinery is only efficient at a minimum size

• Below that size it wont operate efficiently

• Smaller firms cant afford to operate or purchase the machinery at the minimum size

Define managerial economies of scale

• A larger scale firm can benefit from the specialisation of managers

• Can afford to hire specialist managers that can help improve efficiency and morale

Define marketing economies of scale

• Large firms can negotiate lower rates for supplies due their ability to bulk buy

• Can also advertise their products at a lower costs as they have stronger bargaining power compared to smaller firms.

Define financial/capital raising economies of scale

• Larger firms can often borrow from banks at a lower rates of interest and on better terms

• Because they are viewed as low risk by financial institutions due to their strong stream of revenue

Define risk bearing economies of scale

• Large firms are less exposed to risks as they can spread risks by diversifying their output, markets and sources of supply.

• Such economies of diversification can make firms less vulnerable to sudden changes in demand or supply

Define economies of scope

• Firms reduce their average cost per unit by producing multiple products using the same resources

• This also applies to marketing- a strong brand image allows firms to advertise multiple products under 1 name. Reducing costs

• E.g. Apples ecosystem

Reason for diseconomies of scale

• Firms may suffer as they grow in size for various different reasons

Managerial diseconomies of scale

• As a firm grows administration (management) of the firm becomes more difficult

• Delegation of managerial functions to people lower in the organisation may lead to bad decisions

• More rules and regulation(bureaucracy) in a large firm may cause a delay of approval for new products or capital

• Lack of coordination between departments

How does communication failure contribute to managerial diseconomies of scale

• Too many layers of management causing a barrier between workers and managers

• This may lead to staff feeling underappreciated and more like a replaceable asset

• Staff may then become unproductive and costs begin to rise

Motivational diseconomies of scale

• Harder to satisfy and motivate workers in large firms

• Over specialisation may lead to de-skilling as workers perform repetitive mundane tasks

• They have little incentive to use personal initiative which could boost innovation

How does performing tasks repetitively lead to de-skilling ?

• Traditional problem solving and craftsmanship skills become less exercised due to a reliance on capital

• Stunting creativity

Define internal economies of scale?

• Cost saving resulting from the growth of the firm itself

Define external economies of scale

• Cost saving resulting from the growth of the market/industry the firm is apart of

What is the cluster effect?

• Can cause external economies of scale

• When firms in the same industry are located close together providing sources of supply and a pool of labour for each other

What are external diseconomies of scale caused by?

• The cluster effect operating in a negative way

• Large number of similar firms located close together could mean there is competition for labour

• This can cause an increase in wages which increase costs

• May also increase traffic congestion locally, lengthening delivery times and raises delivery costs for consumers and firms

How can market fragmentation lower the significance of economies of scale?

• Market segmentation is when the market is broken down into smaller sectors based on certain characteristics and caters to different consumer wants and needs

• Economies of scale relies on mass production of the same good which is not effective when producing goods that complement different types of people

• increases costs because divergent machinery may be needed, advertising costs if the products have to be marketed differently and different raw materials.

Define total revenue

• All the money received by a firm from selling its total output

Average revenue formula

• Total revenue/output

Average revenue=

Price