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Costs, Revenues
and profit
(HL ONLY)
2
Adding more of the
VARIABLE FACTOR when there are FIXED factors
(In SR)
1
Class Task
using table
1.1 add in
the MPP
curve
AP
The relationship between APP and MPP (In SR)
Table 1.1.1
1
The relationship between
AVERAGE, MARGINAL & TOTAL Physical Product
(in SR)
APP & 3 TPP
MPP
Class Task
using table
1.1.1 to add TP
detail
AP
1
Number of workers
MP
The Theory of Production
Key Terms 2
• Increasing marginal returns
– Where the addition of an extra variable factor adds more to output that
the previous variable factor
• Average product
– The total product divided by the number of workers
• Law of diminishing marginal returns
– Where increasing amounts of a variable factor are added to a fixed
factor and the amount added to total product by each additional unit of
the variable factor eventually decreases
• Optimal output
– The ideal combination of fixed and variable factors to produce the
lowest average cost
• Productive efficiency
– When a firm operates at minimum average total cost, producing the
maximum possible output from inputs into the production process
• Depreciation
– In relation to fixed assets, all fall in the value of an asset during its
working life
FIXED, VARIABLE & SEMI-VARIABLE
(in SR)
Total
Costs
Class Task
complete the
diagram to
include FC,
VC and TC
Output
The Theory of Production
Key Terms 3
• Semi-variable costs
– Costs which have both a fixed and variable element e.g. landline
telephone usage
• Average fixed costs
– TFC/Q
• Average total costs
– TC/Q
• Marginal costs
– The cost of the extra unit of output
Costs in more detail (SR)
Table 1.2
Increasing and decreasing SHORT RUN COSTS
Class Task
Use table 1.2
MC to complete
the diagram
Costs
AC
2 Output
MC, AC, AVC & AFC (in SR)
Costs £’s
Class Task
Use table 1.2
to complete
the diagram
Quantity
Questions for thought
Costs £’s
Quantity
Which factory size would you choose if your
firm needed to produce 100 units?
Costs £’s
SRAC1
SRAC2 What about
175 units?
SRAC3
What will
influence your
decision?
Costs £’s
LRAC1
LRAC2
Costs £’s
LRAC4
LRAC3
Costs £’s
lowest point on the LRAC (or LRAC4
LRATC)
• MES defined as the first
point at which all possible
economies of scale are fully
utilized
• There is unlikely to be one
MES
point rather a range of Quantity
35
Where P=5
Q
1 7
The relationship between D, AR, MR, TR & PED for a
downward sloping linear demand curve
P
Class Task
Use table 7.4
to complete
the diagram
Q
Review of Revenue
• When PED > 1 firms revenue increases if
P falls
• When PED < 1 firms revenue increases if
P increases
• When PED = 1 firms revenue stays the
same as P changes, revenue is already
maximised
Profit Theory
• The economist versus the accountant
– Accountant: Profit = TR – TC
– Economist: Profit = TR – TC but;
• Where TC = FC + VC + Opportunity Cost
– An accountant may deduce that a firm is making a
profit whereas an economist may conclude that they
are making a loss
– 3 scenarios to consider;
• The shut down price
• The break even price
• The profit maximising level of output
The Shut Down Price
• Firms often continue to produce even if they are making
a loss
– During the six months to September 2009, the company (BA)
suffered a £292m ($485m) loss. BBC, 9th Nov 2009
• Firms may even shut down for a period and then re-open
later on
– 1,700 jobs to go as Corus mothballs plant BBC, 4th Dec 2009
– Jobs axed at Ford, Nearly a hundred jobs are being cut at Ford’s
plant in Dagenham as a result of the economic downturn The
company has introduced 14 "non production days" until the
new year in its stamping departments. It'll mean 520 staff
could have to work 3 day weeks. BBC Nov 2008
– An ice cream shop shuts for winter and then reopens when the
weather improves
Why are they still in business?
The Shut Down Price
• The shut down price is the level of price
that enables a firm to cover its variable
costs in the SR, i.e. it is the price where
P=AVC. If price does not cover AVC, then
the firm will shut down in the SR
The Shut Down Price (ATC, AVC and MC)
Class Task
complete the
diagram
Q (Units)
Breaking Even
• In the long run firms are able to cover ATC
• Remember ATC includes OC and is
different for an economists and an
accountant
• If the price does not cover all costs in the
LR the firm will shut down and stay shut
Where does the firm opperate?
• Assumption: Firms seek to
maximise profit
• A firm will continue to produce until
MC=MR why?
Output
Price and Cost
Class Task
complete the
diagram to
show a firm
maximising
profits in the
production of
television sets
Q (Units)
Price and Cost
Class Task
Compare firms
making a
profit, making
a loss and
breaking even
(normal profit):
HINT shift the
AC
Q (Units)
Alternatives to Profit Max
• Revenue Maximisation (MR=0)
• Sales (Volume) Maximisation (AR=AC)
• Employment
• Environment
• Satisficing
Ideas Board 1