4 - Production, Cost and Revenue

Question 1

What are the factors of production?

Answer 1

Inputs into the production process, such as land, labour, capital and enterprise

Question 2

What is land, labour, capital and enterprise?

Answer 2

Land - the actual earth crust
Labour - includes all people employed by the firm who are paid wages.
Capital - warehouses, vehicles, machinery
Enterprise - the entrepreneurs that decide what to make and how to make it. Also decided how much of each factor of production to employ.

Question 3

What is the productivity gap?

Answer 3

The difference between labour productivity.

Question 4

What is productivity?

Answer 4

Output per unit of input.

Question 5

What is labour productivity?

Answer 5

Output per worker.

Question 6

What is the importance of labour productivity in the UK?

Answer 6

It is a big problem affecting the UK, ‘productivity puzzle’ the UK labour productivity has not recovered as well from the recession as other countries.

Explanations: inadequate investment in capital goods, relatively low wages.

Question 7

What is a firm?

Answer 7

Business

Question 8

What is specialisation?

Answer 8

A worker only performing one task or narrow range of tasks. Also a firm only producing one good or service.

Question 9

What is the division of labour?

Answer 9

Different workers perform different tasks in the course of producing a good or service.

Question 10

What are the three main reasons why firms should use specialisation and division of labour to produce goods or services, instead of one worker doing all task?

Answer 10

1. A worker will not need to switch between tasks so time will be saved.
2. More and better machinery or capital can be employed (from increased funds)
3. ‘Practice makes perfect’ argument, workers become more efficient or productive at the task they do repeat again repeatedly. However this can cause Boredom decreasing productivity.
   (All will reduce production cost so reduce price for consumers)

Question 11

Disadvantages of specialisation of labour?

Answer 11

1.Work become repetitive, which could lower motivation of workers, affecting quality and productivity.
2.There could be more structural employment, as skill might not be transferable. As only do one skill.
3. Variety could decrease for the consumers, specialisation of a type of good.
4. Could be a higher worker turnover for firms (people who quit) if people are dissatisfied leading employees leave regularly.

Question 12

Advantages for specialisation of the labour?

Answer 12

1) Higher output and potentially higher quality, proactive makes perfect, and workers will not switch between tasks.
2) More opportunities for economies of scale, Encourages investment in specific capital – economies of scale
3) More competition and this gives incentives for for s to lower their costs, which helps keeps prices down. Lower unit costs leading to higher profits

Question 13

What is trade?

Answer 13

Buying and selling of goods/services.

Question 14

What is exchange?

Answer 14

Give something in return for something else received, money is a medium of exchange.

Question 15

Why do countries specialise in certain production?

Answer 15

For example with Norway they have lots of oil, so they can trade this good to other countries to get the goods and services they are not able to produce.

Question 16

What is a comparative advantage?

Answer 16

Countries can produces a good at a lower opportunity cost to another.

(Produce a good relatively cheaper than other countries)

Question 17

What are the advantages of comparative advantage?

Answer 17

• Increased supply of stock, so greater world output and economic welfare.
• Outward shift in the PPF curve.
• Lower average cost since the market becomees competitive markets.

Question 18

What are the disadvantages of comparative advantage for countries?

Answer 18

Countries become dependent, so for example if this is wheat if there is a bad season then their economy will suffer.

Question 19

Why was a medium of exchange required?

Answer 19

Transaction used to be conducted through bartering and trading of products such as wheat. But people were not able to get exactly what they wanted. Because goods and services were not always the same value, and could only take place if there was double coincidence of wants, so both parties wanted to trade.

Question 20

Why money a good medium of exchange?

Answer 20

Provides a means to measure the value of different goods, services and also labour.

Question 21

What must money do though to be a good medium for exchange?

Answer 21

Hold its value.
It can then be kept for a long time without expiring.
Also allows people to be able to go into debt, and being able to pay the money back later.

Question 22

What is the difference between the short run and the long run?

Answer 22

In the short run at least one of the factor of production are fixed and in the long run all factors of production are variable.

Question 23

What is the marginal returns of labour?

Answer 23

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 24

Explain the law of diminishing returns.

Answer 24

Diminishing returns occur in the short run when one factor is fixed (e.g. capital)
If the variable factor of production is increased (e.g. labour), there comes a point where it will become less productive and therefore there will eventually be a, so the marginal return of the labour falls.
This is because, if capital is fixed, extra workers will eventually get in each other’s way as they attempt to increase production. For example, think about the effectiveness of extra workers in a small café. If more workers are employed, production could increase but more and more slowly.
An extra unit of labour adds less to the total output than the unit of labour before.
Therefore, total output still rises, but it increases at a slower rate.

Question 25

What is the law of diminishing marginal returns?

Answer 25

At a certain point, employing an additional factor of production causes a relatively smaller increase in output.

Question 26

What is the total returns?

Answer 26

The whole output produced by all the factors of production, including labour, employed by a firm.

Question 27

What is the average returns of labour?

Answer 27

Total output divided by the total number of workers employed. Output per worker over time.

Question 28

Use an example to explain the marginal return? (Could be any factor of production usually labour)

Answer 28

For labour, an example would be employing more staff in a small shop will make it overcrowded and the extra output per unit of labour falls.

Question 29

What does Returns to Scale mean?

Answer 29

Return to scale refers to the rate by which output changes if the scale of all the factors of production is changed.

Question 30

Explain the returns to scale for a plant using this diagram. (plant = establishment (factory/workshop), owned by a firm)

Answer 30

Say that the firm fixed capital is a plant. Initially in the short run the plant can increase production in the short run along A by employing more labour but eventually short-run diminishing marginal returns will set in. In the long run they may expand the size of the workshop to workshop 2. However once this workshop is operational then the firm will be in a new short-run situation, again increasing output until the short-run diminishing returns set in again.

Question 31

What does the increasing returns to scale mean?

Answer 31

When the scale of all the factors of production employed increases then output increases at a FASTER rate.

Question 32

What does the constant returns to scale mean?

Answer 32

When the scale of all the factors of production employed increases then output increases at the SAME rate.

Question 33

What does the decreasing returns to scale mean?

Answer 33

When the scale of all the factors of production employed increases then output increases at a SLOWER rate.

Question 34

a) At what level of output do diminishing marginal returns to labour set in? b) At what level of output do diminishing average returns to labour set in? c) At what level of output do diminishing total returns to labour set in?

Answer 34

Question 35

How can you show the law of diminishing demands on a diagram?

Answer 35

A

Question 36

Explain how the have worked out the average return maximum and marginal returns maximum.

Answer 36

Average return = total output of labour / number of labour employed 6 is the maximum out of labour before it begins to fall from 7 and onwards. Marginal return = total return of (n) - total return of (n - 1) MR of (5) = 50 - 32 = 18 5 is the maximum as after this the marginal return begins to fall.

Question 37

What are fixed costs?

Answer 37

Cost of production which, in the short run, does not change with output.

Question 38

What are the variable cost?

Answer 38

Cost of production which changes with the amount that is produced, even in the short-run.

Question 39

What is the difference between fixed and variable costs?

Answer 39

In the short run, at least one factor of production cannot change, meaning there are some FIXED costs. In the long-run, all factors inputs can change. Means all costs are variable.

Question 40

What is the difference between Long-Run and Short-Run costs?

Answer 40

Short-Run = made up of fixed costs and the variable costs incurred when hiring the services of the variable factors of production. Long-Run = Can’t be fixed costs as it only happens in the short run as firms can’t move seamlessly from one plant (enterprise) size to another. Only Variable Costs

Question 41

What are total costs?

Answer 41

All the costs incurred when producing a particular size of output.

Question 42

How do you calculate Total Cost?

Answer 42

Total Cost = Total Fixed Costs + Total Variable Costs TC = TFC + TVC

Question 43

How do you calculate Average Total Cost? Remember this is TOTAL

Answer 43

Average Total Cost = Average Fixed Cost + Average Variable Cost ATC = AFC + AVC Total = +

Question 44

What are Average Variable Costs?

Answer 44

Total variable cost divided by the size of output.

Question 45

What are the Marginal Cost?

Answer 45

Addition to total cost resulting from producing one additional unit of output.

Question 46

What is Average FIXED Costs? Average Costs

Answer 46

The total fixed costs of employing the fixed factors of production to produce a particular level of output, divided by the size of output.

Question 47

How do you calculate average (fixed) cost?

Answer 47

Average (fixed) Cost = total (fixed) cost / quantity produced AFC = TFC / Q

Question 48

Answer 48

Question 49

Answer 49

Question 50

What does the short run average total cost curve look like?

Answer 50

Question 51

Explain this diagram.

Answer 51

The short run average total cost curve is U shaped due to diminishing returns. This is because the factors of production are fixed. At one point, employing more resources will be less productive, which means the marginal output decreases per extra factor of production. And marginal costs start to increase.

Question 52

Draw the Long Run Average Cost Curve.

Answer 52

Question 53

Explain the Long Run Average Cost diagram.

Answer 53

- Initially, average costs fall, since firms can take advantage of economies of scale. This means average costs are falling as output increases. - After the optimum level of output, where the average costs are at their lowest, average costs rise due to diseconomies of scale.

Question 54

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

Answer 54

If factor inputs become more productive, firms can produce more output with a smaller input. This results in a 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 55

What are internal economies of scale?

Answer 55

Occurs when a firm becomes larger. The average cost of production fall as output increases.

Question 56

Give the examples of Economies of Scale? Use the mnemonic, Really Fun Mums Try Making Pies

Answer 56

Risk-bearing - when a firm becomes larger they can expand their production range. Therefore spread the cost of uncertainty. If one part is not successful, they have other parts of the business to fall back on Financial - Banks are willing to lend loans more cheaply to larger firms, because they re deemed less risky. Take advantage of this. Managerial - Larger firms are more able to specialise and divide their labour. They can employ specialist managers and supervisors which lowers average cost Technological - larger firms can afford to invest in more advanced and productive machinery which lowers average cost. Marketing - Large firms can divide their market budgets across large outputs, so average cost of advertising per unit is less. Purchasing - larger firms can Bulk-buy, means each unit will cost them less (exp. Supermarkets vs cornershops).

Question 57

What are economies of scale?

Answer 57

As output increases, cost fall (long run average cost).

Question 58

What is diseconomies of scale?

Answer 58

As output increases, cost rises (long-run average cost).

Question 59

What is 1. External economy of scale and 2. External diseconomy of scale?

Answer 59

1. A fall in long-run average cost of production resulting from the growth of the market or industry which the firm is a part. 2. A increase in long-run average cost of production resulting from the growth of the market or industry which the firm is a part. (Not change in the firms size itself, that’s INTERNAL, change in industry EXTERNAL)

Question 60

Give some examples of external economies of scale.

Answer 60

Local roads improved, transport cost less for the local industries. More training facilities, less money spent by industries on training.

Question 61

How may diseconomies of scale may take place?

Answer 61

Control - it becomes harder to monitor how productive the workforce is, as the firm becomes larger. Co-ordination - It is harder and complicated to coordination every worker, when there are thousands of employees. Motivation - 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 62

What is the relationship between returns to scale and economies or diseconomies of scale?

Answer 62

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, there is said to be increasing returns to scale. This occurs where there are ECONOMIES of scale and factor inputs become more productive. If, 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 DISECENOMIES of scale, since it occurs when factor inputs become less productive.

Question 63

Show how the relationship between economies of scale and diseconomies of scale on the shape of the long-run average cost curve.

Answer 63

Initially, average costs fall, since firms can take advantage of economies of scale. This means average costs are falling as output increases. After the optimum level of output, where average costs are at their lowest, average costs rise due to diseconomies of scale. The point of lowest LRAC is the MINIMUM EFFICIENT SCAKE. 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 64

Draw out the L-shaped LRAC curve. (Hint - Uses SRAC aswell)

Answer 64

Question 65

Explain this L-shaped LRAC curve.

Answer 65

The diagram above shows the relationship between the SRAC curve and the LRAC curve. The LRAC curve envelopes the SRAC curve, and it is always equal to or below the SRAC curve. The LRAC curve shifts when there are external economies of scale, i.e. when an industry grows. SRAC falls at first, and then rises, due to diminishing returns. In the long run, costs change due to economies and diseconomies of scale. If SRAC = LRAC, the firm operates where it can vary all factor inputs. 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 66

Explain the concept of the minimum efficient scale of production and where it is on the L-shaped long-run average cost curve.

Answer 66

MES is the lowest output at which the long-run average costs has been reduced to the minimum level that can be achieved, which means the firms has benefited to the full from economies of scale.

Question 67

What is Total Revenue and how is it calculated?

Answer 67

Total Revenue (TR) = Price x Quantity Sold This is the revenue received from the sale of a given level of output.

Question 68

What is Average Revenue and how is it calculated?

Answer 68

Average Revenue = Total Revenue / Output AR = TR / Q Is the price each unit is sold for.

Question 69

What is Marginal Revenue and how is it calculated?

Answer 69

Marginal Revenue = change in total revenue / change in output Marginal revenue is the extra revenue earned from the sale of one extra unit. It is the difference between total revenue at different level of output.

Question 70

Draw out the Average Revenue and the firms demand curve.

Answer 70

Question 71

Why is the average revenue curve is the firms demand curve?

Answer 71

The AR curve is the firms demand curve. This is because the average revenue curve is the price of the good. In markets where firms are price takers, the AR curve is horizontal. This shows the perfectly elastic demand for their goods. Profit is the difference between TR and total costs. It is the reward entrepreneurs receive from taking risks.

Question 72

What is profit?

Answer 72

Profit is the difference between total revenue and total costs.

Question 73

How do you calculate profit?

Answer 73

Total Profit = total revenue - total costs

Question 74

What is the Normal Profit?

Answer 74

Normal profit is a situation where a firm makes sufficient revenue to cover its total costs and remain competitive in an industry. It covers the opportunity cost of investing funds into the firm and not elsewhere. It is where total revenue = total costs (TR = TC). The profit is insufficient to attract new firms into the market.

Question 75

What is supernormal profit?

Answer 75

Supernormal profit is the profit above normal profit. This exceeds the value of opportunity costs of investing funds into the firm. This is when TR > TC.

Question 76

How do you find the normal profit and supernormal profit on a graph?

Answer 76

Normal Profit - TR = TC Supernormal Profit - TR > TC

Question 77

a) marginal revenue when output per week increases from 4 to 5 units. b) the level of output at which the firm would make the normal profit but not abnormal profit. c) the profit-maximising level of output per week.

Answer 77

Question 78

What is the role of profit in a market economy?

Answer 78

1. The creation of worker incentives 2. The creation of shareholder incentives 3. Profits and resource allocation 4. Profit as a reward for innovation and risk taking 5. Profit as a source of businesses finance

Question 79

What is the role of profit in a market economy, in creating of workers incentives?

Answer 79

Increase workers motivation as profit related or performance related pay, workers will work harder and share the objectives of the owners. However this can also be counterproductive if workers see higher management and owners earning receiving huge wage bonuses whilst workers are on low wages.

Question 80

What is the role of profit in a market economy, in creating of shareholder incentives?

Answer 80

High profit normally leads to high dividends or distributed profit being paid to shareholders who own companies. This creates incentives to buy companies shares and invest. The company’s share price rises, which makes it cheaper and easier for a business to rise finances.

Question 81

What is the role of profit in a market economy, in profits and resource allocation?

Answer 81

High profits creates incentives for new firms to enter markets and produce this good or service. Same way if profits fall then this creates incentives for firms to leave the market and deploy their resources in more profitable markets.

Question 82

What is the role of profit in a market economy, as a reward for innovation and risk taking?

Answer 82

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. Entrepreneurs seek to maximise their profits.

Question 83

What is the role of profit in a market economy, as a source of business finance?

Answer 83

Profit can be retained, so they are kept within the firms and not given to shareholders as dividends. This can be a source of finance for firms if they choose to make an investment. It helps them avoid the costs of interest payments if they borrow money.

Question 84

What is the difference between innovation and invention?

Answer 84

Invention is the process of creating a new product or a new way to make a product. Innovation is the act of improving or contributing to existing products.

Question 85

What is the effect of Technical Change on economic performance?

Answer 85

- Methods of Production - Productivity - Efficiency - Costs of Production

Question 86

What is the effect of Technical Change on methods of production?

Answer 86

Main changes of methods of production has been employing robots to do jobs instead. Originally people where using mechanisation where humans would us robots to make jobs easier such as welding tools to make cars. But now it has gone to automation where computer-controlled machinery will now control the welding tools themselves to make cars.

Question 87

What is the effect of Technical Change on productivity?

Answer 87

Mechanised and Automated production both cause an increase in productivity. Products can be made quicker and to better quality the. Humans could have done. This is why phones are so cheap. Cheaper to produce and quality improved significantly. However so,e times these schemes can fail where productivity can decrease or stay the same, the NHS invested in a very expensive computer system which did not work and had to be scraped.

Question 88

What is the effect of Technical Change on efficiency?

Answer 88

Technological change generally improves productive efficiency and dynamic efficiency. By increasing productivity, TC shifts the short-run and long-run cost curves downwards therefore increasing these efficiency. Productive efficiency = when the average total cost of production is minimised. Dynamic efficiency = measure improvements in productive efficiency.

Question 89

What is the effect of Technical Change on firms’ cost of production?

Answer 89

In the short run but especially in the long run technological change reduces costs. In the long run firms can invest in new capital equipment and technology

Question 90

How can technological change influence the structure of markets?

Answer 90

Monopolies do not have an incentive to innovate, since they have no competition. This means they are often inefficient and their costs are higher than they could be. Oligopolies tend to have more of an incentive to innovate, since they are earning supernormal profits and are trying to get ahead of their competitors. This means that technological change is quite fast in oligopolies

Question 91

What is ‘creative destruction’ and how is it linked to technical change?

Answer 91

Schumpeter, an economist, proposed the idea of ‘creative destruction’. 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. Technological change can lead to the development of new products, the development of new markets and may destroy existing markets. For example, the development of DVDs, then blu-rays, and now the rise of downloadable films, has essentially destroyed the market for VHS video tapes.

Question 92

Examples of comparative advantage

Answer 92

Cote D’ivoire is the main exporter on cocoa. For example Ireland has a comparative advantage in cheese and butter due to climate and a large amount of land suitable for dairy cows. China has a comparative advantage in electronics because it has an abundance of labor.