3.3 - Revenues, costs and profits

Question 1

Define costs

Answer 1

The expenses incurred in production.

Question 1

Define total cost

Answer 1

total fixed cost + total variable cost

Question 2

Define fixed costs

Answer 2

Costs which don’t change with output.
TFC = Fixed costs x price

Question 3

Define variable costs

Answer 3

Costs which do change with output.

Question 4

Define average cost/average total cost

Answer 4

The cost of production per unit.
AC = Average fixed costs + average variable cost
ATC = Total cost/quantity

Question 5

Define average revenue

Answer 5

The price each unit is sold for.

Question 6

Define constant returns to scale

Answer 6

Output increases by the same proportion that input increases by.

Question 7

Define decreasing returns to scale

Answer 7

Output is increasing by a smaller proportion than input is increasing by.

Question 8

Define diminishing marginal productivity/returns

Answer 8

As additional units of a variable factor are added to a given quantity of a fixed factor, the output from each additional unit of the variable factor will eventually diminish. (Less extra output than the previous unit; after a certain point, marginal
output falls).

Question 9

Define diseconomies of scale

Answer 9

The disadvantages that arise in a large business that cause long run average costs to rise as output rises.

Question 10

Define economies of scale

Answer 10

The advantages that arise in a large business that cause long run average costs to fall as output rises.

Question 11

Define external economies of scale

Answer 11

Business-enhancing factors that occur outside a company but within the same industry.

Question 12

Define increasing returns to scale

Answer 12

Output is increasing more than proportionately than input is increasing by.

Question 13

Define internal economies to scale

Answer 13

Business-enhancing factors that occur within a businesses’ control and is independent to other firms or the industry in general.

Question 14

Define loss

Answer 14

When revenue doesn’t cover costs. (TC>TR)

Question 15

Define marginal cost

Answer 15

The additional cost of producing one extra unit of good.
MC = Change in TC / Change in Q

Question 16

Define marginal revenue

Answer 16

The additional revenue gained by selling one extra unit of good
MR = Change in TR / Change in Q

Question 17

Define profit

Answer 17

Total revenue - total costs

Question 18

Define normal profit

Answer 18

The minimum return needed to keep a firm operating, without exceeding the costs. This occurs when TR = TC.

Question 19

Define supernormal profit

Answer 19

The amount by which TR > TC

Question 20

Define explicit costs

Answer 20

Direct payment to others in the course of running a business, such as wage rent and materials.

Question 21

Define implicit costs

Answer 21

The opportunity costs of the fop used to make a good/service. For example, the time invested in training employees.

Question 22

Explain the shape of the MC curve (tick shaped)

Answer 22

• Initially the MC curve is downwards sloping as each additional worker costs the same but is adding more to total output than the previous due to specialisation.
• Once the LODMR sets in, workers are producing less than the previous but still being paid the same.
• Afterwards, MC starts to rise.

Question 23

Explain the shape of the SRAC curve (u shaped)

Answer 23

• Initially the AC curve falls as outif the MC curve is below it.
• Once the LODMR sets in, eventually there will be a level of output where MC rises above AC, causing AC to rise.

Question 24

Explain the shape of the AFC curve

Answer 24

• AFC constantly falls as output increases.
• This is because TFC will always be fixed in the short run, therefore if you divide it by an increasing quantity, AFC will always be downwards slopping.

Question 25

Explain the shape of the AVC curve (u shaped)

Answer 25

• MC will cross AVC at its minimum point as if:
  MC < AVC then AVC will fall with falling MC (falls as output rises)
  MC > AVC then AVC will rise with rising MC
  (rises as output rises)

Question 26

Explain the shape of the TFC curve

Answer 26

TFC is just a horizontal line as fixed costs remain constant.

Question 27

Explain the shape of the TC curve

Answer 27

• TC is upwards sloping (increases with output as more labour is added), at first at a decreasing rate then at an increasing rate after a certain point.
• Repetition of the TVC curve just shifted up the value of the TFC to reflect its constant nature.

Question 28

Explain the shape of the TVC curve

Answer 28

-TVC is upwards sloping (increases with output as more labour is added), at first at a decreasing rate.
- Once the LODMR sets in, mc will start to rise which can be seen as an inflexion point on the TVC curve.
- This is because there’s underutilised capital and specialisation gains to be made by adding more workers.
- After this point the gradient gets steeper, causing TVC to increase at an increasing rate.

Question 29

Explain the shape of the AR curve

Answer 29

• In an imperfect market e.g. monopoly, to sell more firms must lower their price.
• Therefore, the AR curve is the same as the demand curve for a product (AR = D), price is inversely proportionate to the quantity demanded.
• AR is likely to fall as quantity demanded/output rises, this is because each additional unit earns a lower revenue (MR falls) as a result of the lower price charged.

Question 30

Explain the shape of the MR curve
(in imperfectly competitive market)

Answer 30

• Downwards sloping into the negative axis, this reflects the reduction in revenue resulting from the lower price charged.
• 2x steeper than AR

Question 31

Explain the shape of the TR curve
(in imperfectly competitive market)

Answer 31

TR rises with output at first but eventually starts to fall. This is because the extra revenue gained from decreasing price and selling more units is outweighed by the loss in revenue from selling units at a cheaper price than before.

Question 32

Explain RISK BEARING as an internal economy of scale

Answer 32

• Businesses can spread their opportunity cost (risks) over a larger output, by diversification.
• They can sell a wider range of goods or in a wider range of markets. E.G. by selling in different countries.

Question 33

Explain FINANCIAL as an internal economy of scale

Answer 33

Lower rates of interest as a business gets larger, this is because they’re lower risk when a business is successful therefore they can negotiate lower rates.

Question 34

Explain MANAGENIAL as an internal economy of scale

Answer 34

• As a firm gets larger they can employ specialist managers.
• This means they can oversee and improve production system, stream-lining processes and increase productivity.

Question 35

Explain TECHNICAL as an internal economy of scale

Answer 35

Larger businesses able to invest in specialist machinery and efficient factory usage to decrease production costs and increase productivity.

Question 36

Explain MARKETING as an internal economy of scale

Answer 36

Firms can bulk-buy advertising as the cost of advertising is spread out over a larger number of potential customers.

Question 37

Explain PURCHASING as an internal economy of scale

Answer 37

• Firms are able to buy raw materials in bulk, as they grow.
• This is because they’re able to negotiate discounts with their bargaining power.

Question 38

Explain TRANSPORT economies as an internal economy of scale

Answer 38

• Large firms making bulk orders may be charged less for delivery costs than smaller firms.
• Additionally, as firms grow they may have their own transport fleet which will cost less because they won’t be paying other firms who will include a profit margin with it.

Question 39

What is the revenue maximisation point

Answer 39

TR is maximised when MR = 0 and the PED of AR is 1

Question 40

What is the effect of an elastic PED on revenue

Answer 40

When the PED of AR is elastic, firms should decrease its prices to increase its revenue.

Question 41

What is the effect of an inelastic PED on revenue

Answer 41

When the PED of AR is inelastic, firms should increase its prices to increase its revenue.

Question 42

What is the effect of unitary PED on revenue

Answer 42

When the PED of AR is unitary, firms should keep prices unchanged if they’re wishing to increase revenue as its maximised at this point.