Theme 3 Topic 3

Question 1

Revenue

Answer 1

How much money is earned from sales of goods and services

Question 2

Total revenue

Answer 2

Total amount of money coming into the business through sales of goods and services

TR = R x Q

Question 3

Average revenue

Answer 3

Demand = AR

TR / output

Question 4

Marginal revenue

Answer 4

Extra revenue a firm makes selling one extra unit

MR = change in TR / change in output

Question 5

MR +

Answer 5

TR increase as firms sell products at a lower price, so the demand curve is elastic.
Up until output Q, demand curve is inelastic

Question 6

MR 0

Answer 6

TR same and maximised, and demand curve is unitary elastic.
After MR = 0, TR is maximised, but we receive negative marginal revenue and TR falls.

Question 7

MR -

Answer 7

TR decrease as prices decrease, and so the demand curve is inelastic.
After output Q, demand curve is inelastic.

Question 8

Perfectly elastic demand curve

Answer 8

Some firms experience this, meaning they are in perfect competition.
There is no price setting power (price taker).
Every unit of output is sold at the same price.
Higher price decreases sales to zero.
Lower prices leads to sellers lowering their price.
TR increases at a constant rate.
MR = AR = demand

Question 9

Unitary elasticity

Answer 9

MR = 0, PED = 1

Question 10

Imperfect competition features

Answer 10

The firm is a price maker.
To sell an additional unit of output, price (AR) must be lowered.
Both AR and MR fall with extra units of sale.
When AR falls, MR falls by twice as much.
Gradient of MR is twice as steep as AR curve.
TR is maximised when MR = 0

Question 11

Imperfect competition high prices

Answer 11

Change in price leads to greater change in demand.

Question 12

Imperfect competition low prices

Answer 12

Changes in prices leads to a smaller change in demand

Question 13

Upside down U shape (TR)

Answer 13

As prices fall initially, more people buy the product (price elastic) and so revenue rises until point of maximum revenue.
As they keep lowering prices further, demand will eventually become inelastic, and so demand doesn’t increase significantly, so thru will start making less money and revenues fall.

Question 14

Opportunity cost of production

Answer 14

The economic cost of production for a firm is the opportunity cost of production; the value that could have been generated had the resources been employed in their next best use.

In the short run, at least one factor of production is fixed and cannot be changed and so therefore some costs are fixed whilst in the long run, all costs are variable e.g. more property can be used so rent becomes higher.

Question 15

Total cost (TC)

Answer 15

The cost of producing a given level of output.

Fixed + variable costs

Question 16

Total fixed cost (TFC)

Answer 16

costs that do not change with output and remain constant e.g. rent and machinery

Question 17

Total variable cost (TVC)

Answer 17

costs that change directly with output e.g. materials

Question 18

Average (total) cost (ATC)

Answer 18

Total costs / output

Question 19

Average fixed cost (AFC)

Answer 19

Total fixed cost / output

Question 20

Average variable cost (AVC)

Answer 20

total variable cost / output

Question 21

Marginal cost (MC)

Answer 21

Extra cost of producing one extra unit of a good

Total cost of producing N goods - total cost of producing (N - 1) goods

Change in total cost / change un output

Question 22

Short run

Answer 22

That period of time in which at least one factor of production is fixed. E.g. it is difficult to change machinery or the number of factories in the short run, but this can be achieved in the long run. The variable factor that is usually added to production is labour as it is easier to hire new workers

Question 23

Long run

Answer 23

That period of time in which all of the factors of production are variable. This is also called the planning stage as firms can plan for increased capacity and production

Question 24

Marginal product of labour MP

Answer 24

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

Question 25

Law of diminishing marginal productivity

Answer 25

In the short run, as more of a variable factor (e.g. labour) is added to fixed factors (e.g. capital), there will initially be an increase in productivity. However, a point will be reached where adding additional units begins to decrease productivity due to the relationship between labour and capital

Question 26

Short run cost curves

Answer 26

In the short-run, the shapes of the cost curves (AC, AVC and MC) are determined by the law of diminishing marginal productivity In the short run, marginal product (MP) increases with the addition of three workers before diminishing returns for each additional worker begin

Question 27

Short run cost curves diagram analysis

Answer 27

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

Question 28

Connection between diminishing marginal returns and the cost curves

Answer 28

As the marginal product increases, marginal costs decrease There is an inverse relationship Increasing returns = decreasing costs Decreasing returns = increasing costs

Question 29

Connection between diminishing marginal returns and the cost curves diagram analysis

Answer 29

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

Question 30

SR + LR average cost curves

Answer 30

Day-to-day operations of a firm occur in the short-run In the long-run, they are able to plan to increase the scale of production E.g by increasing the size of the factory Larger scale = more output and the firm moves onto a new SRAC curve in which the average unit costs are lower In the long-run, a growing firm is likely to keep repeating this process. Each time a more efficient SRAC is generated The long-run average cost curve (LRAC) is the line of best fit between the lowest points of the short-run ATC curves - Up until output Q1, the firm experiences economies of scale and so sees falling LRAC. • From output Q1 until output Q2, the firm has constant returns to scale where their LRAC are constant • Any output above Q2 means the firm experiences diseconomies of scale and their LRAC rises

Question 31

How can profits be maximised

Answer 31

To maximise profit firms should produce up to the level of output where marginal cost (MC) = marginal revenue (MR)

Question 32

What do economists consider when calculating costs

Answer 32

both the explicit and implicit costs of production

Question 33

explicit costs

Answer 33

Explicit costs are the costs which have to be paid e.g raw materials, wages etc.

Question 34

implicit costs

Answer 34

Implicit costs are the opportunity costs of production This is the cost of the next best alternative to employing the firm's resources Implicit costs must be considered as entrepreneurs will rationally reallocate resources when greater profits can be made elsewhere

Question 35

Profit equation

Answer 35

Profit = total revenue (TR) - total costs (TC) Total costs include explicit and implicit costs

Question 36

Normal profits equation

Answer 36

TR = TC This is also called breakeven

Question 37

Supernormal profits

Answer 37

TR > TC

Question 38

When does a loss occur

Answer 38

TR < TC

Question 39

The shut down rule (profits)

Answer 39

Firms do not always make a profit and may endure losses for a period Entrepreneurs often keep firms going in the hope that market conditions will change and demand for their products will increase leading to profitability This raises the question, 'when is it the best time for a firm to shut down?' The shut-down rule provides the answer by considering both the long-run and short-run periods

Question 40

SR shut down point

Answer 40

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)

Question 41

SR shut down point diagram analysis

Answer 41

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

Question 42

LR shut down point

Answer 42

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)

Question 43

LR shut down point diagram analysis

Answer 43

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

Question 44

What is the minimum efficiency scale ?

Answer 44

Lowest point on the average cost curve. The output level at which the average costs are minimised. As a firm grows, EOS helps a firm to reach its minimum efficient scale before DOS dais the cost/unit again.

Question 45

increasing returns to scale

Answer 45

EOS

Question 46

decreasing returns to scale

Answer 46

DOS

Question 47

economies of scale diagram analysis

Answer 47

Each subsequent short-run average cost (SRAC) curve represents growth and an increase in size Output increases with each period of growth Initially firms experience increasing returns to scale as a result of the economies of scale At a certain level of output, the firm will reach the minimum efficient scale where it experiences constant returns to scale If it continues to grow beyond that level of output the firm will experience decreasing returns to scale as diseconomies of scale occur

Question 48

when does external economies of scale occur

Answer 48

when there is an increase in the size of the industry in which the firm operates. the firm benefits from LRATC generated by factors outside the firm.

Question 49

internal EOS

Answer 49

When the average costs of a business decrease as the output of an individual firm increases in the long run. There are a 6 main economies of scale

Question 50

6 examples of internal EOS

Answer 50

1. Managerial 2. Purchasing 3. Financial 4. Marketing 5. Technical 6. Risk bearing

Question 51

Managerial EOS

Answer 51

Larger firms can afford more specialized managers E.g. HR manager, best production manager, best Marketing teams. This leads to greater efficiency in that department and therefore lower average costs.

Question 52

Purchasing EOS

Answer 52

• The larger the firm the more likely it is able for them to buy their raw materials in bulk. When a business bus in bulk they are usually able to negotiate lower prices and discounts which leads to lower average costs. • Compare a Bagala's bargaining power with Carrefour

Question 53

Financial EOS

Answer 53

Larger firms have access to wider ranges of sources of finance as they are less risky compared to smaller firms. They can negotiate lower interest rates and sells shares on the stock market instead of borrowing money- Both resulting in lower costs. Compare a small independent coffeeshop trying to secure finance versus Starbucks.

Question 54

Marketing EOS

Answer 54

As a firm grows bigger, the cost of advertising is spread out over a larger number of potential customers and products and theretore reducing average costs. E.g. If Apple advertise their brand it will cover advertising for Iphone, Macbooks, Watches, airpods etc

Question 55

Technical EOS

Answer 55

These refer to gains in productivity/efficiency from scaling up production. 1. Large-scale businesses can afford to invest in specialist capital machinery. For example, a supermarket might invest in database technology (via checkout) that improves stock control and reduces transportation and distribution costs. Smaller businesses cannot afford this. 2. Division of labour. Big firms can adopt DoL more easily and therefore enjoy the gains. 3. Law of increased dimensions (container principle Businesses are able to transport their goods around the world at a lower costs. E.g. if a business doubles their container dimensions and therefore their costs but in consequence it increases the volume 8 fold, average costs will decrease.

Question 56

Risk bearing EOS

Answer 56

As a firm expands it is able to develop a range of products and a wider customer base to spread risk and minimize the impact of one of their products failing as they can rely on the others.

Question 57

What is external EOS

Answer 57

when lower average costs of production result from a growth in the size of the industry in which a firm operates

Question 58

Agglomeration economies

Answer 58

Businesses in similar industries tend to cluster together and attract an influx of skilled talent which then provides human capital to expanding businesses.

Question 59

4 sources of external EOS

Answer 59

1. Geographic clustering 2. Skilled labour pool 3. Improved transport links 4. Favorable government legislation

Question 60

Geographic clustering

Answer 60

When many firms in the same industry (including support firms) locate close together, lowering costs for everyone e.g. car manufacturers around Sunderland benefit from suppliers

Question 61

Skilled labour pool

Answer 61

Large industry clusters attract skilled workers, so it’s easier and cheaper to hire specialised labour.

Question 62

Improved transport links

Answer 62

As industries grow, governments invest more in roads, transports, logistics, reducing costs transport links around the M4 Corridor Tech Area between Reading and Bracknell in the UK have experienced significant improvement.

Question 63

Favorable government legislation

Answer 63

Supports through incentives like tax breaks reducing a firms LRAC. E.g. the animation cluster in Bristol and Bath is growing due to the tax incentives offered to the industry by the Government

Question 64

Evaluating EOS

Answer 64

• All firms can gain economies of scale, but how much they gain depends on how efficiently they expand output. • Technology and production methods determine the minimum efficient scale (MES) and whether it is large or small relative to market demand. • Capital-intensive industries have high fixed costs, so they need large output to minimise costs, leading to oligopoly or monopoly. • Labour-intensive industries have lower fixed costs, meaning a low MES and more competition. • Economies of scale do not last forever — once exhausted, firms experience constant returns to scale and stable LRAC. • High capacity utilisation is crucial, as spreading fixed costs over more output reduces average costs. • Firms may use dynamic pricing (e.g. discounts) to boost demand and increase capacity utilisation. • Small firms can still compete by serving niche markets, differentiating products, and avoiding diseconomies of scale

Question 65

Main summary for internal EOS

Answer 65

Expansion of the firm itself Lower long run average cost (LRAC) as output increases Increasing returns from large scale production Range of economies e.g. technical & financial

Question 66

Main summary for external EOS

Answer 66

Expansion of the industry of which the firm is a member Benefits most / all firms Agglomeration economies are important Helps to explain the rapid growth of many cities

Question 67

Diseconomies of scale

Answer 67

increase in long run average costs as output increases- a firm moves beyond their minimum efficient scale

Question 68

Main reasons for DOS

Answer 68

1. Problems in communication may decrease efficiency 2. Workers in a larger company may develop a sense of alienation and low morale leading to a decrease in efficiency 3. Lack of coordination between departments - leading to a decrease in efficiency 4. Culture clashes when firms merge - leading do a decrease in efficiency'