Production, Costs and Revenue

Question 1

What does production do

Answer 1

Converts inputs, or the services of factors of production, into final output

Question 2

Productivity

Answer 2

A measure of efficiency that calculates the amount of outputs produced per unit of input

Question 3

Labour productivity

Answer 3

Output per worker

Question 4

Benefits of specialisation and division of labour

Answer 4

1. Higher output and potentially higher quality, since production focusses on
   what people and businesses are best at.
2. There could be a greater variety of goods and services produced.
3. There are more opportunities for economies of scale, so the size of the
   market increases.
4. There is more competition and this gives an incentive for firms to lower their
   costs, which helps to keep prices down.

Question 5

Disadvantages of specialisation and division of labour

Answer 5

1. Less developed countries might use up their non-renewable resources too
   quickly, so they might run out.
2. Countries could become over-dependent on the export of one commodity,
   such as wheat. If there are poor weather conditions, or the price falls, then
   the economy would suffer.

Question 6

Functions of Money

Answer 6

1. A medium of exchange
2. A measure of value (of goods/services)
3. A store of value
4. A method of deferred payment (allows for debts to be created)

Question 7

Short Run

Answer 7

The period of time over which at least 1 factor input is fixed

Question 8

Long Run

Answer 8

The period of time over which all factor inputs are variable

Question 9

Marginal Returns

Answer 9

Refers to the additional output gained from increasing one unit of input (labour) while keeping all other inputs constant

Question 10

Average Returns

Answer 10

Is the total output divided by the total input (units of labour). It provides a measure of efficiency or productivity over a period

Question 11

Total Returns

Answer 11

Is the overall output obtained from a given level of input (units of labour)

Question 12

The Law of Diminishing Returns

Answer 12

If increasing quantities of a variable input are combined with a fixed input, eventually marginal and then average output (product) of that variable input will decline.

Question 13

Returns to Scale

Answer 13

How a firm’s output changes as it increases or decreases its inputs (labour, capital, etc.)

Question 14

Increasing Returns to Scale

Answer 14

%ΔOutput > %ΔInput

Question 15

Decreasing Returns to Scale

Answer 15

%ΔOutput < %ΔInput

Question 16

Constant Returns to Scale

Answer 16

%ΔOutput = %ΔInput

Question 17

Fixed Costs

Answer 17

Costs which do not change with output e.g. insurance, rent, business rates – these still have to be paid even if the firm does not manufacture anything.

Question 18

Variable Costs

Answer 18

Costs which change with output – the more that is made the higher these costs will be e.g. raw materials, components, energy.

Question 19

Total Costs

Answer 19

Fixed Costs + Variable Costs = TOTAL COSTS

Question 20

Average Costs

Answer 20

How much it costs to manufacture each item

Question 21

Marginal Costs

Answer 21

The addition to total cost of producing one extra unit of output

Question 22

Short-run Costs

Answer 22

Short-Run Costs include both fixed and variable costs, but some factors (like the size of the factory) are fixed.

Question 23

Long-run Costs

Answer 23

Long-Run Costs encompass all costs, and all factors of production, including the size of the facility, can be adjusted

Question 24

Reason for the shape of the Marginal Cost Curve

Answer 24

U-Shaped Curve:
Initially decreases due to increasing specialization, then increases due to diminishing returns

Question 25

Reasons for the Shape of Average Cost Curve

Answer 25

U-Shaped Curve:
Similar to the marginal cost curve, reflecting economies of scale and then diseconomies of scale.

Question 26

Reasons for the Shape of the Total Cost Curve

Answer 26

Rises Steadily:
Due to the fixed costs that remain constant regardless of production level.

Question 27

How factor prices and productivity affect firms’ costs of production and
their choice of factor inputs

Answer 27

If factor inputs become more productive, firms can produce more output with a
smaller input. This results in lower unit costs of production.
As the average cost per unit of one factor input rises, such as labour, firms are likely
to switch to cheaper (and generally more productive) factor inputs, such as capital.

Question 28

Internal Economies of Scale

Answer 28

These occur when a firm becomes larger. Average costs of production fall as output
increases

Question 29

External Economies of Scale

Answer 29

Economies of scale, represented by a downward shift of the average cost curve, which arise from a growth in the size of the industry in which the firm operates.

Question 30

Reasons for Diseconomies of Scale

Answer 30

1. Workers feel alienated (small fish in a big pond)
2. Communication becomes slow and inefficient
3. Decision making becomes slow and inefficient

Question 31

The relationship between returns to scale and economies or diseconomies of scale

Answer 31

Returns to scale increases when the output increases by a greater proportion to the
increase in inputs. For example, if input doubles, and output quadruples. This occurs where there are economies of scale
and factor inputs become more productive.
On the other hand, a doubling of input leads to a 1.5 times increase in output,
there are decreasing returns to scale. This is linked to diseconomies of scale, since it
occurs when factor inputs become less productive.

Question 32

The relationship between economies of scale, diseconomies of scale and the shape of the long-run average cost curve

Answer 32

The long-run average cost (LRAC) curve is directly influenced by economies of scale and diseconomies of scale. Businesses frequently realise economies of scale during the early phases of industrial expansion, which results in a downward-sloping LRAC curve. The LRAC curve eventually hits a minimum point, which represents the smallest scale of production that is still efficient, after which diseconomies of scale take hold and the curve slopes higher.

Question 33

The L-shaped long-run average cost curve

Answer 33

The L-shape curve is a development in cost theory from the traditional U-shaped
curve. It suggests that to begin with, costs per unit fall as output increases, due to
economies of scale.
Even if there are diseconomies of scale within the firm, such as if managerial costs
increase, they are offset by the economies of scale gained by technical or production
factors.
This means that in the long run, costs continue to fall, even if the pace of falling
output costs slows (shown by the flat part of the curve)

Question 34

The concept of the minimum efficient scale of production

Answer 34

The point of lowest LRAC is the minimum efficient scale. This is where the optimum
level of output is since costs are lowest, and the economies of scale of production
have been fully utilised.

Question 35

Marginal Revenue

Answer 35

The extra revenue earned from the sale of one extra unit.
It is the difference between total revenue at different levels of output.

Question 36

Total Revenue

Answer 36

Calculated by price times quantity sold. This is the revenue
received from the sale of a given level of output.

Question 37

Why is the AR curve the demand curve

Answer 37

The average revenue curve is the price of the good.

Question 38

The relationship between average and marginal revenue

Answer 38

When demand is perfectly elastic, marginal revenue = average revenue.

Question 39

The relationship between marginal revenue and total revenue

Answer 39

Marginal revenue measures the change in total revenue with respect to changes in
the amount of goods and services sold. Marginal revenue is calculated by the change in total revenue divided by the change in quantity sold.

Question 40

Profit

Answer 40

The difference between total revenue and total costs

Question 41

Normal profit

Answer 41

TR=TC

Question 42

Abnormal (supernormal) profit

Answer 42

TR>TC

Question 43

The role of profit in a market economy

Answer 43

1. Profit is the reward that entrepreneurs yield when they take risks and make investments
2. An entrepreneur wants to avoid loss and gain profit, which makes them want to
   innovate, so they can reduce their production costs and improve the quality of their products
3. Profits can be retain for investment, helps them avoid the costs of interest payments if they borrow money
4. Incentive for new firms to enter the market

Question 44

Invention

Answer 44

the process of creating a new product or a new way to make a product.

Question 45

Innovation

Answer 45

is the act of improving or contributing to existing products.

Question 46

Creative destruction

Answer 46

This is the idea that new entrepreneurs are innovative, which challenges existing firms. The more productive firms then grow, whilst the least productive are forced to leave the market. This results in an expansion of the economy’s productive potential.