1.4 Production, costs, and revenue

Question 1

Production

Answer 1

converting inputs into outputs of goods and services

Question 2

Factors of production (4)

Answer 2

Inputs into the productive process; land, labour, capital enterprise

Question 3

Total cost

Answer 3

the entire cost of producing at a particular level of output

Question 4

Total Cost Formula

Answer 4

fixed costs + variable costs

Question 5

Fixed costs

Answer 5

fixed costs are costs that do not change with the level of output produced by a firm.

Question 6

Variable cost

Answer 6

cost of production which changes with the amount that is produced

Question 7

Marginal cost (MC)

Answer 7

the change in total costs from change in one unit of output

Question 8

Average cost (AC)

Answer 8

the total cost divided by the quantity produced

Question 9

Total product

Answer 9

the total amount of output produced by a firm with a given amount of inputs (like labor, capital, and land) in a specific period of time.

Question 10

Long run production

Answer 10

all factors of production are variable

Question 11

Short run production

Answer 11

In short-run (SR) production, at least one factor of production (usually capital, such as machinery or factory space) is fixed, while others can be varied.
output can only be increased by adding more variable inputs (e.g., hiring more workers) but not by expanding fixed inputs.

A key concept in SR production is diminishing marginal returns as more variable inputs (e.g., workers) are added to a fixed input (e.g., a factory), each additional worker contributes less to output than the previous one. This happens because overcrowding or limited resources reduce efficiency. As a result, marginal product (MP) initially rises but eventually falls, leading to rising marginal costs (MC) in the short run. Firms aim to produce where marginal cost equals marginal revenue (MC = MR) to maximise profit, even if they cannot adjust all inputs immediately.

Question 12

Division of labour

Answer 12

The division of labour refers to the process of breaking down a production task into smaller, specialised tasks performed by different workers. This increases efficiency and productivity, as workers focus on specific roles where they can develop expertise.

Question 13

Price competition

Answer 13

when a firm reduces prices in order to sell more goods

Question 14

Productivity

Answer 14

output per unit of factor of production

Question 15

Labour productivity

Answer 15

Output per unit of labour

Question 16

Capital productivity

Answer 16

Output per unit of capital

Question 17

Law of diminishing returns

Answer 17

where increasing amounts of a variable factor are added to a fixed factor and the amount added to total product by each unit (ie the marginal and average product) of the variable factor eventually decreases

Question 18

Advantages of division of labour (4)

Answer 18

Specialisation – Workers become skilled at a narrow task, improving speed and quality.

Increased Productivity – Repetition reduces time wasted switching tasks (e.g., assembly lines).

Lower Costs – Higher output per worker reduces average production costs.

Time-Saving – No need for workers to learn multiple skills, speeding up production.

Question 19

What do changes in marginal product suggest about average cost?

Answer 19

• as marginal product rises, average product is rising and average cost is falling
• as marginal product falls, average product is falling and average cost is rising

Question 20

Functions of money (4)

Answer 20

• medium of exchange
• measure of value
• store of value
• standard of deferred payment

Question 21

Specialisation

Answer 21

Specialisation occurs when individuals, firms, regions, or countries focus on producing a limited range of goods or services where they have a comparative advantage (the ability to produce at a lower opportunity cost than others). This increases efficiency

Question 22

Absolute advantage

Answer 22

where a country can produce more of a good than other countries with the same amount of resources

Question 23

Trade

Answer 23

the buying and selling of goods and services

Question 24

Internal economies of scale

Answer 24

long-run average costs falling caused by growth of the firm [due to increasing returns to scale)

Question 25

Internal diseconomies of scale

Answer 25

long-run average costs rising caused by growth of the firm [due to decreasing returns to scale)

Question 26

External economies of scale

Answer 26

long-run average costs falling caused by growth of the industry or market of which the firm is a part

Question 27

External diseconomies of scale

Answer 27

long-run average costs rising caused by growth of the industry or market of which the firm is a part

Question 28

Productively Efficient Output

Answer 28

output with the lowest average cost of production; occurs where MC = AC

Question 29

Types of internal economies of scale (6)

Answer 29

- risk-bearing - financial - managerial - technological - marketing - purchasing

Question 30

Risk-bearing economies of scale

Answer 30

- When a firm becomes larger, they can expand their production range. - Therefore, they can spread the cost of uncertainty. - If one part is not successful, they have other parts to fall back on.

Question 31

Financial economies of scale

Answer 31

Banks are willing to lend loans more cheaply to larger firms, because they are deemed less risky. Therefore, larger firms can take advantage of cheaper credit.

Question 32

Managerial economies of scale

Answer 32

- Larger firms are more able to specialise and divide their labour. - They can employ specialist managers and supervisors, which lowers average costs.

Question 33

Technological economies of scale

Answer 33

Larger firms can afford to invest in more advanced and productive machinery and capital, which will lower their average costs

Question 34

Marketing economies of scale

Answer 34

Larger firms can divide their marketing budgets such as advertisement across larger outputs, so the average cost of advertising per unit is less than that of a smaller firm Advertising Costs Small Business: Spends £1,000 on ads to sell 100 units. → Advertising cost per unit = £10. Amazon: Spends £100 million on ads but sells 1 billion units. → Advertising cost per unit = £0.10.

Question 35

Purchasing economies of scale

Answer 35

- Larger firms can bulk-buy, which means each unit will cost them less. For example, supermarkets have more buying power from farmers than corner shops, so they can negotiate better deals

Question 36

Types of internal diseconomies of scale (3)

Answer 36

- control - co-ordination - communication

Question 37

Control diseconomies of scale

Answer 37

It becomes harder to monitor how productive the workforce is, as the firm becomes larger.

Question 38

Coordination diseconomies of scale

Answer 38

It is harder and complicated to coordinate every worker, when there are thousands of employees.

Question 39

Communication diseconomies of scale

Answer 39

Workers may start to feel alienated and excluded as the firm grows. This could lead to falls in productivity and increases in average costs, as they lose their motivation.

Question 40

examples of external economies of scale (3)

Answer 40

Skilled Labour Pool – More trained workers available (e.g., tech firms in Silicon Valley). Infrastructure Improvements – Better transport/networks due to industry demand. Supplier Clusters – More local suppliers reduce costs (e.g., car manufacturers near steel plants).

Question 41

Total revenue

Answer 41

all the money received by a firm from selling its total output

Question 42

Total revenue =

Answer 42

Price x Quantity

Question 43

Average revenue (AR) =

Answer 43

total revenue/quantity

Question 44

Marginal revenue (MR) =

Answer 44

change in total revenue / change in quantity

Question 45

Revenue maximisation occurs at

Answer 45

MR=0

Question 46

Describe the relationship between the MR curve and the AR curve

Answer 46

The MR curve falls twice as quickly as the AR curve

Question 47

Profit-maximising level of output occurs at

Answer 47

MR = MC

Question 48

Sales maximisation occurs at

Answer 48

AC = AR

Question 49

Profit

Answer 49

the difference between total revenue and total cost

Question 50

Total profit =

Answer 50

total revenue - total cost

Question 51

Normal profit

Answer 51

the minimum profit required to keep factors of production in their current use in the long run, however insufficient to attract new firms to the market

Question 52

Abnormal/supernormal profit

Answer 52

The profit over an above normal profit

Question 53

Subnormal profit

Answer 53

profit below normal profit

Question 54

Shutdown point

Answer 54

The shut down price is the minimum price a business needs to justify remaining in the market in the short run A business needs to make at least normal profit in the long run to justify remaining in an industry but in the short run a firm will continue to produce as long as total revenue covers total variable costs or price per unit > or equal to average variable cost (AR = AVC). This is called the short-run shutdown price.

Question 55

Chain of production

Answer 55

the route that a good takes (through primary, secondary, and tertiary sectors) from being a raw material to being a good

Question 56

Value added tax (VAT)

Answer 56

an indirect tax imposed on the value added at each stage of production and distribution of goods and services. It is ultimately paid by the final consumer but collected and remitted to the government by businesses.

Question 57

Marginal returns of labour

Answer 57

the change in the quantity of total output resulting from the employment of one more worker, holding all the other factors of production fixed

Question 58

Average returns of labour

Answer 58

total output divided by the total number of workers employed

Question 59

Total returns of labour

Answer 59

total output produced by all workers employed by a firm

Question 60

Long-run

Answer 60

the time period in which no factors of production are fixed and in which all the factors of production can be varied

Question 61

Increasing returns to scale

Answer 61

increasing the scale of all factors of production causes a more than proportionate increase in output

Question 62

Constant returns to scale

Answer 62

increasing the scale of all factors causes a proportionate increase in output

Question 63

Decreasing returns to scale

Answer 63

increasing the scale of all factors of production causes a less than proportionate increase in output

Question 64

Minimum efficient scale (MES)

Answer 64

the lowest output at which the firm is able to produce at the minimum achievable LRAC

Question 65

Barriers to entry

Answer 65

makes is difficult or impossible for new firms to enter the market

Question 66

Natural monopoly

Answer 66

where there is only room in a market for one firm benefitting from economies of scale to the fullest

Question 67

Examples of natural monopolies

Answer 67

railways, water network, electricity grid, broadband network

Question 68

why are these examples of natural monopolies?

Answer 68

- all have high infrastructural costs - a market structure with one firm would therefore have lower LRAC than a structure with more than one

Question 69

Describe the LRAC curve of a natural monopoly

Answer 69

- falls continuously over a large range of output - result may be that there is only room in a market for one firm to fully exploit the economies of scale that are available and therefore achieve productive efficiency

Question 70

Describe the LRAC curve for perfect competition

Answer 70

- horizontal line - firms neither benefit from economies of scale nor suffer diseconomies of scale - no firm is at a cost advantage or disadvantage to other firms

Question 71

invention

Answer 71

making something entirely new; something that did not exist before

Question 72

Innovation

Answer 72

improves on or makes significant contribution to something that has already been invented, thereby turning the results of invention into a product

Question 73

dynamic efficency

Answer 73

occurs in the long run, leading to the development of new products and more efficient processes that improve productive efficiency

Question 74

Creative destruction

Answer 74

a process where firms produce or create innovative new products that replace or destroy existing products in the market

Question 75

Why might improvements in technology cause demand for labour to increase?

Answer 75

- makes labour more productive (output per worker increases) so demand increases - demand for a certain type of labour may decrease, causing demand for another type to increase

Question 76

Why might improvements in technology cause demand for labour to decrease?

Answer 76

- increases capital productivity and may cause firms to want to adopt automated production processes, causing demand for labour to fall - demand for a certain type of labour may increase, causing the demand for another to decrease

Question 77

How does an improvement in dynamic efficiency affect the LRAC curve?

Answer 77

downward shift

Question 78

How has the invention of e-commerce affected firms? (4)

Answer 78

- firms can now exist without physical premises - reduced barriers to entry as it is easier to enter the market without having to set up a physical outlet/branch - number of firms increase - larger range of products for consumers to choose from, with the ability to compare prices easily

Question 79

primary sector

Answer 79

extractive and agricultural industries (e.g. farming, logging, hunting, fishing, and mining)

Question 80

Secondary sector

Answer 80

industries involved in producing consumer goods and capital goods

Question 81

tertiary sector

Answer 81

the part of the economy that involves the provision of services rather than the production of goods.

Question 82

disadvantages to division of labour(3)

Answer 82

Monotony & Worker Dissatisfaction – Repetitive work can reduce motivation. Over-Reliance on Specific Workers – Absences or strikes can disrupt production. Structural Unemployment Risk – If a task becomes automated, specialised workers may struggle to adapt.

Question 83

economies of scale

Answer 83

Economies of scale occur when a firm's average costs of production (AC) fall as its output increases. This happens because larger firms can spread costs over more units, operate more efficiently, and negotiate better deals.

Question 84

changes in fixed costs

Answer 84

shifts ac only

Question 85

changes in variable costs

Answer 85

shifts ac and mc

Question 86

mes

Answer 86

The minimum efficient scale (MES) is: The lowest level of output at which a firm can produce while fully exploiting all available economies of scale and therefore achieving the lowest possible average cost. 👉 It’s the output level at the bottom of the long-run average cost (LRAC) curve where constant returns to scale begin. ✅ Beyond MES → firm cannot lower average cost any further by increasing output.