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notes Unit 3 - Business behaviour and the labour market
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detailed notes Unit 3 - Business behaviour and the labour market alevel economics A edexcel
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Business behaviour and the labour market3.3 revenues, costs and profits:
Total revenue (TR) – amount received from all its sales of goods and services, the total amount of money made from the sale of
goods and services.
- Price x quantity
Average revenue (AR) – revenue per unit.
- TR/quantity.
- AR=demand curve.
Marginal revenue (MR) – extra revenue gained from selling one extra unit of output.
- Gradient of TR curve.
- Change in TR / change in output.
- Twice gradient of AR.
Elasticities:
Perfectly elastic demand curve – firms in perfect competition, no price setting power – price received is constant and so MR=AR=D.
- TR upward sloping as prices are constant so more goods sold, higher revenue.
For most, price decreases as output increases – downward sloping demand curve so AR curve.
- Imperfect competition so some price setting power.
- Elastic part – TR increases when prices fall as demand increases slightly more than the fall in
price.
o If firms lowers price, TR increases.
o MR is positive, firms sells good at lower price and TR still grows until MR=0.
- Inelastic part – TR increases as increased prices leads to smaller decrease in sales, so selling
fewer at proportionately higher price so TR increases.
o If firms lowers price, TR decrease.
o MR is negative, TR decreases as price decreases.
- MR = 0, TR maximised
- U-shaped TR, at first, TR rises with output (MR positive), but begins to decline (MR negative).
Total cost (TC) – cost of producing a given level of output, rewards to FoP.
- FC + VC.
Total fixed cost (TFC) – costs that don’t vary with output. Rent.
Total variable cost (TVC) – costs that vary directly with output, materials.
ATC, AFC, AVC – total of them / output.
Marginal cost – extra cost of producing one extra unit of a good.
- Change in total cost / change in output.
- Goes through minimum point of AVC and AC curves – if marginal cost is greater than average cost, average will be rising,
only time average is not falling/rising is when MC=AC and average has stopped falling and has yet to start rising. (May be
explained with increasing + diminishing returns/economies + diseconomies?).
Short run – situation in which only variable FoP can be changed, land + capital fixed, labour + raw materials variable.
Increasing returns to scale – Av. cost decrease in SR.
- Is when average cost per unit decreases in the short run, each additional unit of variable is adding more to output than
previous, causing AC to fall. Output increases at increasing rate.
Diminishing returns to scale – AV. cost increase in SR.
- Is when AC/unit increases in short run, each additional unit of variable is adding less to output than previous, causing AC to
rise. Output increases at decreasing rate.
Long run – situation in which all FoP are variable.
Economies of scale – when AC/unit decreases in LR.
o Internal – cost advantages enjoyed by a firm as it gets bigger.
§ Purchasing – buying in bulk.
§ Financial – firms negotiate lower interest rates when borrowing die to risk.
§ Law of increased dimensions.
§ Marketing.
§ Risk-bearing – spread risk of new products + cover any downturn.
§ Managerial.
o External – cost advantages enjoyed by firms in the same industry + located in the same geographical area.
§ Share cost of innovation, transport.
§ Labour tends to come to that area for a job – reducing cost + time taken to recruit.
Diseconomies of scale – when AC/unit increase in LR.
o Internal – cost disadvantages as firms gets bigger/too big.
§ Slower decision making, increased paperwork, breakdown in communication/managerial difficulties ->
LRAC increasing. Increased productive inefficiencies+ waste.
, o External – cost disadvantages by too many firms in the same place.
§ Congestion, pollution.
MES – minimum efficient scale, lowest point of LRAC, minimum level of output needed for. Business to fully exploit economies of
scale.
Constant returns to scale – firm increase inputs + receive increased output by same percentage.
Firms assumed to be profit maximisers – MC=MR, sometimes may decide to go for revenue maximisation or sales maximisation.
Profit maximisation- MC=MR, MC must also be rising, where firm maximises profits/minimises losses.
- SNP are at greatest.
- MC has to be rising as the next unit sold will cause MC to rise above MR and so a fall in total profit.
Normal profit – minimum profit required to keep firm in an industry.
- AC = AR
Supernormal profit – any profit greater than normal profit.
- AR>AC or TR>TC
Shut down points: when making a loss, may not be best decision to shut down straight away – depends on AVC.
- AVC<AR, firms should continue producing, each good made will generate more
revenue than it costs to make so will help reduce size of loss.
- AVC>AR, producing more will increase loss and so should leave industry
immediately.
- LR – firm needs to make least normal profit to stay in industry, in SR should
produce as long as revenue covers variable costs, so SR shut-down point is
where AVC=AR.
Business objectives:
- Profit maximisation:
o MC=MR
o Firm maximises profits/minimises loses.
- Revenue maximisation:
o MR=0
o Firm seeks to make as much revenue as possible, willing to sell until last unit sold adds nothing to TR as next unit
sold will reduce TR. 2 diagrams earlier on.
- Sales maximisation:
o AC=AR
o Firm sells as much as possible without making a loss.
o Firms attempting to increase size of their business.
- Sales + rev max necessitates a fall in price – others may copy and so may be no or little increase in sales/rev – important in
oligopoly. They also bring lower profits.
- Satisficing:
o When a firm aims to make a minimum accepted level of output and then pursues other aims.
o Make enough profit to keep owners happy whilst following other objectives.
- Managerial utility maximisation:
o Mangers make decisions to maximise their own satisfaction.
- Marginal cost pricing/allocative efficiency:
o Aim to maximise social welfare, produce where vale society places on good= extra cost of producing that good,
MC=AR, achieves allocative efficiency.
Pricing strategies – firms can decide to adopt several strategies to gain market share/increase profitability in LR while sacrificing SR
profits.
- Predatory pricing – reducing prices to drive out other firms.
o In SR firm makes a loss but as other firms leave, prices are raised to higher levels than would’ve been possible with
competition.
o Incumbent firm lowers price to lower price than AC of new potential firm, new firm unable to enter as it’ll be
operating at a loss.
o Incumbent firm has lower AC as been in industry longer and so benefits from economies of scale.
- Entry limit pricing – reducing prices to discourage new firms entering.
o Ensures price is below what new firm can sustain, exploits economies of scale that an incumbent firm has.
- In SR, both benefit consumer as lower prices, but when firm manages to get monopoly power from getting rid of
competition, it will be able to raise prices – reducing consumer surplus and consumer choice.
- Cost-plus pricing – making a fixed % mark-up on AC, price discrimination + discount pricing – buy one get one free. These
can lead to greater consumer loyalty and increase LR profits.
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