Year 13 Micro IPM One Notes
Revenue, Costs and Profits
Revenue
Revenue is the total money earned from the sale of goods and services.
- Total Revenue is the total amount of money coming into the business through the sale
of goods and services, quantity x price.
- Average Revenue is equal to demand; total revenue/output.
- Marginal Revenue is the extra revenue that the firm earns from selling one addition unit
of production; it is equal to change in total revenue/ change in output.
Profit = Revenue – Costs
For goods with a downward sloping demand curve, the elasticity of the curve is linked to
marginal revenue.
- If marginal revenue is positive, when the firm sells the product at a lower price, total
revenue continues to grow and therefore the demand curve is elastic up until point Q.
- If marginal revenue is negative, TR decreases as price decreases (or output increases),
therefore after point Q the demand curve is inelastic.
- When MR = 0, TR is maximised, demand curve is unitary elastic.
- The gradient of MR is always twice the gradient of AR.
- Therefore, total revenue is a U-shape because before point Q, revenue rises as marginal
revenue is positive, but decreases when marginal revenue is negative.
,Costs
The economic cost of production for a firm is the opportunity cost of production; the value
that could have been generated had the resources been employed in their next best use.
- Short-Run is when at least one factor of production is fixed and cannot be changed;
some costs are always fixed.
- Long-Run is when all costs are variable; for example, when more property can be used
so rent becomes higher.
Types of Cost:
- Total Cost – The cost of producing a given level of output: fixed + variable costs.
- Total Fixed Costs – Costs that do not change with output and remain constant e.g. rent
and machinery
- Total Variable Costs – Costs that change directly with output e.g. materials.
- Average Total Costs – Total Costs/Output
- Average Fixed Costs – Total Fixed Costs/Output
- Average Variable Costs – Total Variable Costs/Output.
- Marginal Cost – The extra cost of producing one additional unit of output; change in
total costs/change in output.
Diminishing Marginal Productivity; if a variable factor is increased when another factor is
fixed, there will come a point where each extra unit of the variable factor will produce less
extra output than the previous unit.
- AFC = Average Fixed Costs – Starts high because whole fixed costs are being divided by a
small output, as output increases, AFC decreases.
- ATC = Average Total Costs – U-Shaped due to the law of diminishing marginal
productivity. Costs initially fall as machinery is used more efficiently but after a certain
point, adding a factor of production has a negative impact as machinery is overused.
, - MC – U-Shaped due to the law of diminishing marginal productivity.
- The MC always intersects the AC curve at the AC lowest point. This is because if MC is
below AC, AC will continue to fall since producing one more costs less than the average
so the average falls; if MC is above AC, AC will rise. However, MC can be rising while AC
is falling , as long as MC is still below AC.
- SRAC curves are U-shaped due to the law of diminishing marginal productivity, whilst
long run average cost curves are U-shaped due to economies and diseconomies of scale.
LRAC and SRAC
- LRAC is always either equal to or below the relevant SRAC. SRAC can increase as, in the
short run, firms need to produce more than they currently do and at least one of their
factors of productions is fixed, therefore SRAC increases due to diminishing marginal
returns. In the long run, as all factors of production become variable, the SRAC curve can
be shifted to a new point on LRAC. The new SRAC curve is lower as the firm is able to
enjoy economies of scale; however after constant returns to scale, SRAC and LRAC
increase again due to diseconomies of scale.
- The LRAC curve represents the minimum level of average costs attainable at any given
level of output. Points below the LRAC are unattainable and points above the LRAC
demonstrate inefficiency.
- Movement along the LRAC is caused by a change in output which changes the average
cost of production due to internal economies/diseconomies of scale. A shift can occur
due to external economies/diseconomies, which affect cost of production for a given
level of output.
, Economies and Diseconomies of Scale
Economies of scale are the advantages of large-scale production that enable a large business
to produce at a lower average cost than a smaller business. As a result, a firm is able to
experience increasing returns to scale where an increases in inputs by a certain percentage
will lead to a greater percentage increase in outputs.
Diseconomies of scale are the disadvantages that arise in large businesses that reduce
efficiency and cause average cost to rise. The firm experiences decreasing returns to scale,
where output increases by a smaller percentage than input increases.
Constant returns to scale is when firms increase input and receive a proportional increase in
output. The minimum efficient scale is the minimum level of output needed for a business to
fully exploit economies of scale.
Internal Economies of Scale
Internal Economies of Scale are advantages that firms are able to enjoy due to growth of the
firm, independent of anything happening to other firms or the industry in general. These
include:
Technical Economies arise as a result of what happens to the production process.
- Specialisation: Large firms are able to appoint specialist workers and buy specialist
machines which are more productive and efficient.
- Increased Dimensions: More than proportional increases than initial increases for
example land, doubling wall leads to 4x area.
- Indivisibility of Capital: Some processes require huge items of machinery and investment
that make production only possible on a large scale.
- Research and Development: Large firms can carry out large scale research and
development, meaning they can gain a large advantage over competitor.
Financial economies arise when large firms have greater security as they have more assets,
meaning they are less likely to be abruptly forces out of business. As a result, it is easier for
them to obtain finance and interest rates are lower due to lower risk. Investment is
therefore more accessible.
Risk-Bearing economies arise when large companies are able to operate in a range of
different markets, producing different products, meaning if one area of business fails the
whole business does not collapse.
Managerial Economies arise when large companies can afford to appoint specialist managers
in every field, who have greater knowledge and can therefore perform their job better.
Marketing and Purchasing Economies:
- Buying in bulk: Large firms are able to buy in large numbers, and therefore may be able
to buy their raw materials at a cheaper price than competitors.
