3.3 Revenues, Costs and Profits

Question 1

What is total revenue?

Answer 1

Total revenue is the total value of all sales generated by a firm.

Question 2

State the formula for total revenue.

Answer 2

Total revenue (TR) is calculated using the formula: Selling price (P) x Quantity sold (Q)

Question 3

Define average revenue.

Answer 3

Average revenue is the revenue per unit, or price.

Question 4

What is marginal revenue?

Answer 4

Marginal revenue is the extra revenue received from the sale of an additional unit of output.

Question 5

True or False? In perfect competition, MR = AR = Demand.

Answer 5

True.

Question 6

In perfect competition, how does total revenue increase?

Answer 6

In perfect competition, total revenue increases at a constant rate.

Question 7

What happens to AR and MR in monopolistic competition?

Answer 7

Both AR and MR fall with additional units of sale in monopolistic competition.

Question 8

When is total revenue maximised in monopolistic competition?

Answer 8

Total revenue is maximised when output is where MR = 0 in monopolistic competition.

Question 9

What is the rule for total revenue?

Answer 9

The rule for total revenue states that to maximise revenue firms should increase the price of products that are price inelastic in demand, and decrease the price of products that are price elastic in demand.

Question 10

How does price elasticity of demand affect total revenue?

Answer 10

When demand is price elastic a decrease in price increases total revenue. When demand is price inelastic an increase in price increases total revenue.

Question 11

True or False? AR is the demand curve.

Answer 11

True.

Question 12

What is the relationship between the MR and AR curves in monopolistic competition?

Answer 12

The gradient of the MR curve is twice as steep as the AR curve in monopolistic competition.

Question 13

What are fixed costs?

Answer 13

Fixed costs are costs that do not change with the level of output.

Question 14

Define variable costs.

Answer 14

Variable costs are costs that change directly with the level of output.

Question 15

What does marginal cost mean?

Answer 15

Marginal cost is the cost of producing an additional unit of output.

Question 16

State the formula for total costs.

Answer 16

Total costs (TC) are calculated using the formula:

Total fixed costs (TFC) + Total variable costs (TVC)

Question 17

How is average total cost calculated?

Answer 17

Average total cost (AC) is calculated using the formula:
TC/Q

Question 18

What is the short-run?

Answer 18

The short-run is a period of time in which at least one factor of production is fixed.

Question 19

Define the long-run.

Answer 19

The long-run is a period of time in which all of the factors of production are variable.

Question 20

What is the law of diminishing marginal productivity?

Answer 20

The law of diminishing marginal productivity states that in the short run, as more of a variable factor is added to fixed factors, there will initially be an increase in productivity. A point will be reached where adding additional units begins to decrease productivity.

Question 21

How are the shapes of short-run cost curves determined?

Answer 21

The shapes of short-run cost curves (AC, AVC & MC) are determined by the law of diminishing marginal productivity.

Question 22

What is the relationship between marginal product and marginal costs?

Answer 22

There is an inverse relationship between marginal product and marginal costs. As marginal product increases, marginal costs decrease.

Question 23

Where does the MC curve cross the AVC and AC curves?

Answer 23

The MC curve crosses the AVC and AC curves at their lowest points.

Question 24

What is the long-run average cost curve (LRAC)?

Answer 24

The long-run average cost curve (LRAC) is the line of best fit between the lowest points of the short-run ATC (SRAC) curves.

Question 25

What are economies of scale?

Answer 25

Economies of scale are the benefits a firm receives from increasing its levels of output in the long run. This causes its long-run average total costs (LRAC) to decrease.

Question 26

What is meant by diseconomies of scale?

Answer 26

Diseconomies of scale are an increase in long-run average total costs (LRAC). This is caused by a firm increasing its level of output beyond the point of its lowest LRAC.

Question 27

What are increasing returns to scale?

Answer 27

Increasing returns to scale occur when a firm is enjoying economies of scale.

Question 28

Define decreasing returns to scale.

Answer 28

Decreasing returns to scale occur when a firm is facing diseconomies of scale.

Question 29

What is the minimum efficient scale?

Answer 29

The minimum efficient scale is the lowest cost point on a long-run average total cost (LRAC) curve.

Question 30

True or False? All economies of scale are internal.

Answer 30

False. Economies of scale can be internal or external.

Question 31

What are external economies of scale?

Answer 31

External economies of scale occur when there is an increase in the size of the industry in which the firm operates. This allows the firm to benefit from lower LRAC generated by factors outside of the firm.

Question 32

How does a geographical cluster contribute to external economies of scale?

Answer 32

A geographical cluster contributes to external economies of scale as supporting firms move closer to major businesses. This cuts costs and generates more sales, lowering the LRAC. ## Footnote An example is Silicon Valley in California, USA.

Question 33

What is a source of external economies of scale related to labour?

Answer 33

An increase in skilled labour can lower the cost of skilled labour. This decreases the LRAC which is a source of external economies of scale.

Question 34

How can legislation affect external economies of scale?

Answer 34

Favourable legislation can generate significant reductions in LRAC. Governments may support some industries helping them gain external economies of scale.

Question 35

True or False? Increasing and decreasing returns to scale only happen in the long run.

Answer 35

True.

Question 36

What determines the shape of long-run cost curves (LRAC)?

Answer 36

Economies and diseconomies of scale determine the shape of long-run cost curves.

Question 37

What is the condition for profit maximisation?

Answer 37

The condition for profit maximisation is that a firm has to produce at the level of output where marginal cost (MC) = marginal revenue (MR).

Question 38

Define direct costs.

Answer 38

Direct costs can be traced to the production of a good or service, such as raw materials and wages.

Question 39

What are indirect costs?

Answer 39

Implicit costs cannot be matched against a product because they need to be paid whether or not production takes place. ## Footnote For example, rent on premises.

Question 40

How is profit calculated?

Answer 40

Profit is calculated using the formula: TR-TC