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Economics > Production, costs and revenue > Flashcards

Production, costs and revenue Flashcards

1
Q

Define Production

A

Production converts inputs, or the services of factors of production, into final output.

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2
Q

Factors of production

A
  • Land: Refers to natural resources used in production.
    Example: Agricultural land, oil reserves.
  • Labour: Human effort involved in the production process.
    Example: Factory workers, software developers.
  • Capital: Man-made resources used to produce goods and services.
    Example: Machinery, buildings, technology.
  • Entrepreneurship: Involves the organization of factors of production to create goods and services.
    Example: Elon Musk founding SpaceX.
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3
Q

When were the factors of production expanded beyond labour

A

By the two Swedish economists Bertil Heckscher and Eli OhlinIn in the early 20th century, the two Swedish economists when formulating the The Heckscher–Ohlin model (builds on Ricardo’s theory of comparative advantage)

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4
Q

Land as a factor of production

A
  • broad definition; can take on various forms,
  • agricultural land
  • commercial real estate
  • the resources available from a particular piece of land
  • The physiocrats: the wealth of nations was derived solely from the value of land
  • Importance of land as a factor can diminish or increase based on industry; real estate v. software engineering
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5
Q

The Labour Theory of Value

A
  • ## the value of economic goods derives from the amount of labour necessary to produce them
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6
Q

Types of Production:

A
  • Primary Production: Extracting raw materials from the earth.
    Example: Mining, agriculture.
  • Secondary Production: Manufacturing raw materials into finished goods.
    Example: Car manufacturing, textile production.
  • Tertiary Production: Providing services.
    Example: Healthcare, education.
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7
Q

Production Functions:

A
  • Linear Production Function: Output increases proportionally with inputs.
  • Formula: Q = a+b⋅L+c⋅KQ = a+b⋅L+c⋅K

QQ: Output
LL: Labour input
KK: Capital input

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8
Q

What is the ISM Manufacturing Index

also known as the purchasing managers’ index (PMI)

A
  • A monthly indicator of U.S. economic activity based on a survey of purchasing managers at more than 300 manufacturing firms
  • Considered to be a key indicator of the state of the U.S. economy
  • Indicates the level of demand for products by measuring the amount of ordering activity at the nation’s factories
  • Conducted by the Institute for Supply Management (ISM)
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9
Q

Current ISM Manufacturing Index

A
  • Fell to 49.2 in April of 2024 from 50.3 in the earlier month, firmly below market expectations of a stall
  • The data reflected a contraction in the US manufacturing sector, failing to maintain earlier traction as the prior month pointed to the first expansion in 16 months
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10
Q

The S&P Global UK Manufacturing PMI

A
  • 49.1 in April 2024
  • down from March’s 20-month high of 50.3
  • a figure above 50 indicates expansion.
  • Highest = 65.6 in May 2021
  • Lowest = 32.6 in Apr 2020
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11
Q

Manufacturing

A
  • The creation or production of goods with the help of equipment
  • The secondary sector of the economy
  • Difference between manufacturing and production is that production can create both goods and services, whilst manufacturing can create only goods
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12
Q

Differences between manufacturing and production

A
  • Production can create both goods and services, whilst manufacturing can create only goods
  • Manufacturing uses tangible raw materials to create goods, such as lumber or minerals. Production, however, uses both tangible raw materials and intangible resources, such as money or credit.
  • Production companies typically have access or ownership of their resources, while manufacturing companies buy their materials from other sources.
  • Production creates utility, while manufacturing creates matter. Utility refers to the usefulness of a good or service, while matter typically refers to a physical item.
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13
Q

UK manufacturers’ sales by product: 2022 results

Annual estimates covered by the ProdCom survey

A
  • The total value of UK manufacturers’ product sales was £429.8 billion in 2022
  • ## The manufacture of food remained the largest division and represented 21% of total manufacturers sales in 2022
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14
Q

Hoc Research briefing
Manufacturing: Key Economic Indicators
Published Friday, 10 May, 2024

A
  • In October–December 2023, the manufacturing sector accounted for 9.3% of total UK economic output (Gross Value Added) and 8.1% of employment.
  • Manufacturing output rose by 0.3% between February and March 2024
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15
Q

Regional manufacturing

A
  • The North West remains the biggest manufacturing area of the UK, worth £28.2bn in output and employing 314,000 people
  • The sector accounts for almost 15% of North West economic output and 8% of regional employment
  • Wales has the highest share of manufacturing with the sector accounting for almost a fifth (17.3%) of the Welsh economy. This compares to just under 10% national average.
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16
Q

Industrial strategy: 2017

A
  • Focused on “five foundations” of productivity
  • Also identified four “grand challenges” facing the UK
  • Also set up an independent Industrial Strategy Council to assess and evaluate the strategy and make recommendations to Gov
  • PM Theresa May: “it will help propel Britain to global leadership of the industries of the future”
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17
Q

The five foundations of productivity in the Industrial strategy: 2017

A
  • Ideas (research and innovation)
  • People (skills, jobs and earnings)
  • Infrastructure (particularly transport, housing and digital technology)
  • Business environment (encouraging business creation and small business productivity)
  • Places (prosperous communities, addressing disparities in regional productivity and spreading the proceeds of growth).
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18
Q

The four “grand challenges” facing the UK in the Industrial strategy: 2017

A
  • The artificial intelligence and data revolution
  • The global shift to clean growth
  • The future of mobility (focused on transport networks, electric vehicles and driverless cars)
  • An ageing society
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19
Q

The four strategic manufacturing sectors??

A

auto, aero, life sciences and clean energy

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20
Q

Productivity

A

a measure of the efficiency with which inputs are transformed into outputs.

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21
Q

Learning-by-doing; productivity

A
  • Concept that productivity is achieved through practice, self-perfection and minor innovations.
  • An example is a factory that increases output by learning how to use equipment better without adding workers or investing significant amounts of capital.
  • The concept has been used by Kenneth Arrow in his design of endogenous growth theory to explain effects of innovation and technical change
  • ## Robert Lucas, Jr. adopted the concept to explain increasing returns to embodied human capital
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22
Q

Three of the major pillars of economic development

A

Specialisation, Division of labour, and Exchange

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23
Q

Specialization

A

Specialization refers to the concentration of individuals, firms, or nations on producing a limited range of goods or services.

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24
Q

The division of labor

A

The division of labor is a form of specialization where tasks are divided among workers

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25
Q

Adam Smith The Wealth of Nations 1776 on specialization & the division of labor

A

He argued that specialization leads to increased productivity and economic growth.

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26
Q

Advantages of Specialization

A
  • Increased Productivity: Specialization allows workers to become more skilled in specific tasks, leading to higher efficiency
  • Economies of Scale: Larger quantities of identical goods can be produced more efficiently
  • Lower Costs: Reduced training time and waste contribute to cost savings
  • Encourages investment in specific capital; economies of scale
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27
Q

Disadvantages of Specialization

A
  • Monotony: Workers may find repetitive tasks monotonous, leading to job dissatisfaction
  • Dependency: An economy heavily dependent on a single industry or export can be vulnerable to economic shocks
  • Risk of structural unemployment due to occupational immobility
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28
Q

Advantages of Specializing for Trade

A
  • Comparative Advantage: Nations can focus on producing goods and services where they have a comparative advantage, leading to higher efficiency
  • Increased Standard of Living: Trade allows access to a wider variety of goods and services, enhancing overall living standards
  • Surplus can be exported, an injection into the circular flow of income
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29
Q

Disadvantages of Specializing for Trade

A
  • Vulnerability to External Shocks: Reliance on trade exposes nations to risks, such as changes in global demand or supply disruptions
  • Income Inequality: Specialization may benefit certain industries or regions more than others, leading to income inequality
  • Might lead to over-extraction of a country’s natural resources
  • Risk of over-specializing and structural unemployment
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30
Q

Functions of Money

A
  • Medium of Exchange: Money facilitates the exchange of goods and services, eliminating the need for barter.
  • Measure of Value: Money serves as a unit of account, providing a common measure of the value of goods and services
  • Store of Value: Money can be saved or stored for future use, preserving its value over time
  • Method of Deferred Payment: Money allows for transactions where payment occurs at a later date
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31
Q

Real-world examples of industries that make extensive use of division of labour:

A
  • Vehicle assembly
  • Construction industry
  • Smartphone assembly
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32
Q

Cost curves

A

Measure the costs that firms have to pay to hire the inputs or factors of production needed to produce output

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33
Q

The short run and the long run

A
  • The time period in which at least one factor of production is fixed and cannot be varied
  • The only way in which a firm can produce more in the short run is by adding more variable factors to fixed factors of production
  • The long run is the time period in which no factors of production are fixed and in which all the factors of production can be varied

short run and long run distinction varies from one industry to another

they are conceptual time periods, the primary difference being the flexibility and options decision-makers have in a given scenario.

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34
Q

Very short run and very long run

A
  • Very short run: Where all factors of production are fixed. (e.g on one particular day, a firm cannot employ more workers or buy more products to sell)
  • Very long run; Where all factors of production are variable, and additional factors outside the control of the firm can change, e.g. technology, government policy. A period of several years.
35
Q

Cost vs. Price

A
  • Cost is the expense incurred for making a product or service that is sold by a company
  • Price is the amount a customer is willing to pay for a product or service
36
Q

Fixed vs. Variable costs

A
  • Fixed costs are the costs a firm incurs when hiring or paying for the fixed factors of production
  • Variable costs change as the level of output changes, even in the short run
37
Q

The difference between marginal, average and total costs.

A
  • Marginal:
  • Average: the total cost production divided by output
  • Total: the whole cost of producing a particular level of output
38
Q
A
  • ## It is directly proportional to the total cost of goods and inversely proportional to the number of goods, so average cost decreases when the number of goods increases.
39
Q

four costs curves for a firm operating in a perfectly competitive market

A
  • Average fixed cost (AFC) refers to fixed costs divided by the total quantity of output produced, AFC = FC/Q.
  • Average variable cost (AVC) refers to variable costs divided by the total quantity of output produced, AVC = VC/Q.
  • Average total cost (ATC) refers to the total cost divided by the total quantity of output produced, ATC = TC/Q.
  • Marginal cost (MC) refers to the additional cost incurred by producing one additional unit of output, MC = ΔTC/ΔQ.
40
Q

Marginal cost

A
  • Marginal Cost = Change in Total Cost / Change in Quantity
  • The marginal cost function is expressed as a derivative of the total cost concerning quantity. It may change with volume, so at each production level, the marginal cost is the cost of the next unit produced.
  • It helps management to make the best decision for the company and utilise its resources in a better and more profitable way, as with quantity, profit increases if the price is higher than the marginal cost.
  • Its curve is concave as when returns increases and then move linearly and smoothly with the constant return and finally change in convex when marginal cost show increase return
41
Q

Whats the aim of Average and Marginal costs

A
  • The average cost aims to assess the impact on total unit cost with a change in output level
  • The marginal cost aims to assess whether it is beneficial to produce an additional unit of goods
42
Q

The MC curve

A

The MC curve always intersects both the AVC curve and the ATC curve at their respective minimum points. When marginal cost is less than average variable or average total cost, AVC or ATC must be decreasing. When marginal cost is greater than average variable or average total cost, AVC or ATC must be increasing. Therefore, the only possible point at which marginal cost equals average variable or average total cost is the minimum point.

43
Q

Break-even Point

A

The point at which marginal cost equals average total cost (MC = ATC) is known as the break-even point. When the MR = P line crosses through this point, the product is said to be selling at its break-even price because the marginal revenue will exactly offset the marginal cost of production, and total revenue will exactly offset total cost. In this situation, the firm will break even: it will not be earning any profits, but it will not be losing money either.

44
Q

What happens if the MR = P line lies above the break-even point?

A

The firm will be operating at a profit, since the revenue earned on each unit of output sold will exceed the average cost of producing a unit of output, and thus total revenue will exceed total cost.

45
Q

What happens if the MR = P line lies below the break-even point?

A

The firm will be operating at a loss because the revenue earned on each unit of output will be less than the average cost of producing a unit of output, and so total revenue will be less that total cost.

46
Q

The key difference between Average Cost vs. Marginal Cost

A

Average Cost refers to the per-unit production cost of the goods produced in the company during the period. In contrast, Marginal cost refers to the value of the increase or decrease of the total production cost of the company during the period under consideration if there is a change in output by one extra unit.

47
Q

Diagram of Marginal Cost

A
  • Because the short run marginal cost curve is sloped like this, mathematically the average cost curve will be U shaped. Initially, average costs fall. But, when marginal cost is above the average cost, then average cost starts to rise.
  • Marginal cost always passes through the lowest point of the average cost curve.
48
Q

Why is Average Cost Curve U-shaped?

A
  • The behaviour of AC curve directly depends upon the behaviour Of AFC and AVC curves
  • In the beginning with increase in output, average cost falls because of the operation of the law of increasing returns. After reaching the minimum point, when we increase the output, average cost starts increasing because of the operation of the law of diminishing returns. Thus due to the law of variable proportions, the AC curve takes U -shape
  • In the short run, when a firm increase the output, due to indivisibilities of some fixed factors of production, it enjoy certain internal economies. These economies result in the fall of AC curve in the beginning. After the optimum point, with an increase in output, the economies are overweighted by the diseconomies which result in the AC curve to increase. Thus the AC curve gets U-shaped.
  • In the long run is assumed to be ‘U’ shaped, because of the impact of internal economies and diseconomies of scale.
49
Q

The law of diminishing marginal returns

also referred to as the “law of diminishing returns,” the “principle of diminishing marginal productivity,” and the “law of variable proportions.”

A
  • After some optimal level of capacity is reached, adding an additional factor of production will result in smaller increases in output.
  • Once diminishing marginal returns set in then marginal costs start to rise.
  • Average costs will fall until they are equal to marginal costs, then they will rise
  • Under diminishing returns, output remains positive, but productivity and efficiency decrease.
  • Only applies in the short run because, in the long run, all factors are variable
  • Plays a central role in production theory.
50
Q

Diminishing returns in the short run

A

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 decreasing marginal and then average product.
This is because, if capital is fixed, extra workers will eventually get in each other’s way as they attempt to increase production.

51
Q

Examples of diminishing returns

A
  • Use of chemical fertilisers. A small quantity leads to a big increase in output. However, increasing its use further may lead to declining Marginal Product (MP) as the efficacy of the chemical declines.
  • Employing extra workers. A cafe may wish to serve more customers during the busy summer months. However, employing extra workers may be difficult because of a lack of space in the cafe.
52
Q

How does a firm expand?

A
  1. Internal growth, also called organic growth
  2. External growth, also called integration – by merging with other firms, or by acquiring other firms

By growing, a firm can expect to reduce its average costs and become more competitive

53
Q

What are Economies of scale

A

The cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of time.
- as output increases, LRAC falls

54
Q

The difference between internal and external economies of scale.

A

The key difference between internal and external economies of scale is the source of the cost advantages. Internal economies of scale arise from a firm’s own growth and optimisation of internal operations, while external economies of scale result from the growth and clustering of multiple firms or the entire industry in a particular location or market, leading to shared cost benefits.

55
Q

internal and external economies of scale endogenous/exogenous

A

Internal Economies of scale is a result of endogenous determinants, i.e. the reasons which are internal to the firm. On the contrary, External economies of scale occur on account of exogenous determinants, i.e. the reasons which are external to the firm.

56
Q

Economies of Scale Advantages of Division of Labour and Specialisation

A

When a firm increases its production volume, more and more manpower of diversifying skills, qualification and experience, are hired. The firm can implement division of labour, to attain specialisation of the workforce, by dividing them according to their expertise.

57
Q

Common limits of economies of scale

A
  • exceeding the nearby raw material supply, such as wood in the lumber, pulp and paper industry.
  • saturating the regional market, thus having to ship products uneconomic distances.
  • using energy less efficiently
  • having a higher defect rate
58
Q

How is economies of scale a justification for free trade internationally

A

Some economies of scale may require a larger market than is possible within a particular country—for example, it would not be efficient for Liechtenstein to have its own carmaker if they only sold to their local market. A lone carmaker may be profitable, but even more so if they exported cars to global markets in addition to selling to the local market.

59
Q

Physical and engineering basis of economies of scale

A
  • Drag loss of vehicles like aircraft or ships generally increases less than proportional with increasing cargo volume,therefore, making them larger usually results in less fuel consumption per ton of cargo at a given speed.
  • ## In some industrial processes, an increase in the size of the plant reduces the AVC, thanks to the energy savings resulting from the lower dispersion of heat
60
Q

Economical use of byproducts economies of scale

A

Karl Marx noted that large scale manufacturing allowed economical use of products that would otherwise be waste.[21] Marx cited the chemical industry as an example, which today along with petrochemicals, remains highly dependent on turning various residual reactant streams into salable products. In the pulp and paper industry, it is economical to burn bark and fine wood particles to produce process steam and to recover the spent pulping chemicals for conversion back to a usable form.

61
Q

Diseconomies of scale

A
  • ## The cost disadvantages a firm receives due to an increase in organisational size or in output, resulting in long run average costs rising
62
Q

Internal diseconomies of scale and External diseconomies of scale

A
  • Internal: can arise from technical issues of production or organisational issues within the structure of a firm or industry.
  • External: can arise due to constraints imposed by the environment within which a firm or industry operates
63
Q

Reasons for Diseconomies of scale

A
  • Managerial diseconomies of scale: As firms become very large, the management structure can become overly complex and less efficient.
  • Communication failure: Communication breakdowns and bureaucracy may increase, leading to higher costs.
  • Motivational diseconomies of scale: In very large organizations, employees may feel disconnected from the company’s goals and values, which can result in lower productivity and higher turnover rates.
64
Q

PES and Diseconomies of scale (external)

A

Inputs with price inelasticity of supply are also a reason for external diseconomies of scale. Imagine a firm experiences significant growth in demand, and as a result, it needs to produce more output. However, those supplying the input for the firm can’t increase the total output by as much as the price increases. This means that the firm will be paying more but not getting as many inputs, which then causes diseconomies of scale.
- In this case, if a firm attempts to increase output, it will need to purchase more inputs, but price inelastic inputs will mean rapidly increasing input costs out of proportion to the increase in the amount of output realized.

65
Q

The supply chain and Diseconomies of scale (external)

A

The firm is dependent on other factors to move its goods around. One of those aspects is traffic. If the routes that a company uses to deliver or their goods are always congested, that might cause delays, especially when dealing with distant markets.

66
Q

tragedy of the commons and Diseconomies of scale (external)

A

External capacity constraints can arise when a common pool resource or local public good cannot sustain the demands placed on it by increased production. The depletion of a critical natural resource below its ability to reproduce itself in a tragedy of the commons scenario. As the resource becomes ever more scarce and ultimately runs out, the cost to obtain it increases dramatically.

67
Q

Profit

A
  • The difference between total revenue and total costs
  • key indicator of a firm’s performance
  • referred to as net income on the income statement
  • Also called ‘the bottom line’
  • When costs exceed revenue, there is a negative profit, or loss
  • Provides insight into the effectiveness of resource usage, efficiency, and overall business health
  • the return for entrepreneurial effort and risk
68
Q

What Is More Important, Profit or Revenue?

A

While both are important, profit gives a more accurate picture of a company’s financial position. That’s because a company’s liabilities and other expenses such as payroll are already accounted for when its profit is calculated.

69
Q

How Much of Revenue Is Profit?

A

Profit is whatever remains from the revenue after a company accounts for expenses, debts, additional income, and operating costs.

70
Q

Types of Profit:

A
  • Normal Profit: The minimum level of profit required to keep a firm in operation. Occurs when AR=ATC
  • Abnormal (Supernormal) Profit: Abnormal profit is the excess profit earned above normal profit, indicating exceptional performance.
    Example: If a tech company introduces a groundbreaking product, the high demand may result in supernormal profits for a certain period.
  • Losses: occur when a firm’s TC exceeds its TR. Can lead to a firm shutting down in the short run if it cannot cover its variable costs.
71
Q

Supernormal profit diagram

A

When the price is P3, the firm makes supernormal profit. This is because at P3, AR is greater than ATC.

72
Q

Profit maximisation

A
  • MC = MR
  • Firm selects the level of output that yields the highest profit
  • In the long run, in a perfectly competitive market, firms produce where the P = MR = MC
  • Ensures not only profit maximization but also that firms do not enter or exit the industry in the long run
73
Q

Short-run and long-run shut down points: Profit maximisation

A

A firm which profit maximises continues to operate in the short run if P > AVC. This
means firms continue to produce in the short run as long as variable costs are
covered.
When shutting down, no variable costs are incurred by the firm. However, fixed costs
have to be paid whether the firm shuts down or continues to produce. This means
that fixed costs are not considered when a decision to shut down is being made.
The shut-down point is P < AVC, when variable costs cannot be covered. This is at the
lowest point on the AVC curve.
When a firm shuts down, it is a short run decision. This means production is only
temporarily stopped. However, in the long run, the firm can leave the industry. This
will happen when TR < TC.

74
Q

Profits can also act as a signal to firms and consumers.

A

For example, in markets where firms make supernormal profits, there are likely to be new firms entering the market since the market seems profitable. This increases market supply and lowers the market price. This assumes the market is contestable and there are no (or low) barriers to entry.

75
Q

Role of profit in dealing with scarcity

A

Scarce economic resources generally flow where rewards to investment are higher.
The factors of production are used in markets where the rate of return is higher.

76
Q

Trade-off between profitability and total profit in the long-term

A

Sometimes, firms focus on maximizing sales rather than profitability to keep prices low and gain market share. This strategy can lead to higher profits in the long run. For example, Amazon made minimal profits for years to expand its market share. Eventually, this approach allowed it to significantly increase its profitability and total profit.

77
Q

Short-run and long-run shutdown points

A
  • Short-run shutdown point: A firm should shut down in the short run if its total revenue (TR) is less than its variable costs (VC), as continuing to operate would increase losses beyond fixed costs.
  • Long-run shutdown point: In the long run, a firm should exit the industry if it cannot cover its total costs (both fixed and variable). In a perfectly competitive market, firms enter or exit until economic profit is zero. Thus, the long-run shutdown point is where TR equals total costs (TC). If TR is less than TC, the firm should exit.
78
Q

Gross profit and net profit

different perspectives on a firm’s financial status

A
  • Gross: TR - Cost of Goods sold
  • Net: Gross profit - (Operating expenses + Taxes + Interest)
79
Q

Economic profit

A
  • Profit considering both explicit and implicit costs
  • Economic = Net Profit − Opportunity Costs
  • Example: If the owner could have earned an additional £500 elsewhere, that opportunity cost is considered an implicit cost
80
Q

Factors Impacting Profit Maximisation

A
  • Market Competition: Firms in highly competitive markets have limited ability to set prices above production costs.
  • Costs of Production: High production costs reduce profit margins. Innovations that lower these costs can boost profits.
  • Demand and Consumer Preferences: Customer demand affects a firm’s pricing power and profit potential.
  • Regulatory Environment: Regulations, such as taxes and wage rules, impact profit margins.
81
Q

The Profit Margin Formula

A
  • Profit Margin(%)= (Net Income/Revenue) x 100
  • Ratio of net income to revenue expressed as a percentage
  • Reveals the portion of each $ of revenue that a company retains as profits.
82
Q

What are the strategies used by companies to increase their profit?

A
  • Cost minimisation
  • Process and productivity improvements
  • Pricing adjustments
  • Market expansion
  • Product differentiation
83
Q

Cost control

A
  • The practice of identifying and reducing business expenses to increase profits

Economics (8 decks)

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