1.3. Production, Costs and Revenue

• Production converts inputs, or services of factors of production, such as capital and labour, into final output
• Productivity is a measure of efficiency and is the rate of output
• • Labour Productivity: the average output per worker
  • Capital Productivity: the output per unit capital
  • Factor Productivity: the output of all factors of production
• Specialisation is when an individual, firm or country focuses on one area of the production process
• Division of Labour is when labour is split into specialised roles
• Specialisation and Division of Labour:

  Advantages:

  • Increased productivity and efficiency
  • Lower prices for consumers due to lower production costs

  Disadvantages:

  • Monotonous work
  • Collapsing economies (Economies not needed anymore)
  • Adverse shocks may benefit diverse economies
  • High structural unemployment due to no versatility
• Specialisation necessitates an efficient means of exchanging goods and services, such as the use of money as a medium of exchange
• Short run: one factor of production remains fixed

  Long run: all factors of production are variable
• • Fixed costs: costs remain the same and are independent to the level of production (no goods produced = still pay)
  • Variable costs: costs that vary and are dependent on the level of production (no goods produced = no pay)
• • Average costs: costs per unit
  • Total costs: fixed costs + variable costs + normal profit
• Examples of Fixed costs:

  • Rent
  • Salaries
  • Insurance
  • Loan repayment

  Examples of Variable costs:

  • Raw materials
  • Wages
  • Bills (Electricity, gas etc)
• The short run average cost curve is U-shaped because as the level of output increases initially, costs decrease from economies of scale. After a certain point, as the level of output increases, costs increase due to diseconomies of scale
• The shape of the long run average cost curve is determined by economies and diseconomies of scale
• Economies of scale - as production increases, average costs per unit decrease
• Internal economies of scale occur from inside the individual firm:

  • purchasing economies (bulk-buying)
  • technical economies (specialist capital: machines)
  • managerial economies (specialist labour: accountants, lawyers)
  • financial economies (better credit ratings as large firms are seen to be less likely to fail and can borrow money at lower interest rates)
• External economies of scale occurs outside of the individual firm:

  • Positive externalities created from other firms
  • Improved transport infrastructure
  • A pool of skilled workers
  • Advanced communication systems
• Diseconomies of scale is when average costs increase with increased output:

  • Poor communication with large firms
  • Poor coordination with large firms
• Label the diagram for the short and long run average cost curve:

  A) Costs

  B) Output

  C) Economies of Scale

  D) Diseconomies of scale

  E) Minimum efficiency scale

  
• Label the diagram for average cost curve:

  A) Costs

  B) Output

  C) LRAC

  D) Economies of scale

  E) Diseconomies of scale

  F) Productive efficiency

  
• • Total revenue = price x quantity
  • Average revenue = price

  This is why the average revenue curve is the firm's demand curve, as it is just the price a good is sold for and the demand curve shows the quantity demanded for a given price
• profit = total revenue - total costs