revenue/costs/profits

• Fixed costs


  Costs that do not change as the level of output changes. These have to be paid whether output is zero or 5000. e.g. building rent, management salaries, insurance, bank loan repayments etc.
• Variable costs


  Costs that vary directly with output. These increase as output increases & vice versa. E.g. raw material costs, wages of workers directly involved in production
• Fixed costs are costs that do not change as the level of output changes
• Fixed costs have to be paid whether output is zero or 5000
• Variable costs are costs that vary directly with output
• Variable costs increase as output increases & vice versa
• Variable costs


  • raw material costs
  • wages of workers directly involved in production
• Marginal cost


  The cost of producing an additional unit of output
• Cost Calculations


  1. Total Fixed Cost (TFC)

  2. Total Variable Cost (TVC)

  3. Total Cost (TC)

  4. Average Fixed Cost (AFC)

  5. Average Variable Cost (AVC)

  6. Average Cost (AC)

  7. Marginal Cost (MC)
• In the short-run, the shapes of the cost curves (AC, AVC & MC) are determined by the law of diminishing marginal productivity
• Short-run


  • At least one factor of production is fixed
• Long-run


  • All factors of production are variable
• Marginal product of labour (MP)


  The change in output that results from adding an additional unit of labour
• Law of diminishing marginal productivity

  In the short run, as more of a variable factor (e.g. labour) is added to fixed factors (e.g. capital), there will initially be an increase in productivity. However, a point will be reached where adding additional units begins to decrease productivity due to the relationship between labour and capital
• As the marginal product increases


  Marginal costs decrease
• Increasing returns


  Decreasing costs
• Decreasing returns


  Increasing costs
• The distance between the AVC & AC = the AFC
• AVC converges towards AC as the AFC continuously decreases with an increase in output
• AVC decreases as additional workers are added & each worker produces additional product
• Marginal costs (MC) decrease initially as additional workers are added & the marginal product is increasing
• Diminishing returns begin when the MC starts to increase
• MC will cross the AVC and AC curves at their lowest point
• As long as the cost of producing the next unit (MC) is lower than the average, it will pull down the average
• When the cost of producing the next unit (MC) is higher than the average, it will pull up the average
• Short-run


  Day to day operations of a firm
• Larger scale = more output & the firm moves onto a new SRAC curve in which the average unit costs are lower
• The long-run average cost curve (LRAC) is the line of best fit between the lowest points of the short-run ATC curves
• The LRAC curve is generated by the addition of successive SRAC as the firm expands its scale of production
• Normal profit


  Occurs when total revenue (TR) = total costs (TC)
• Supernormal profit


  Occurs when total revenue (TR) > total costs (TC)
• Loss


  Occurs when total revenue (TR) < total costs (TC)
• Explicit costs are the costs which have to be paid e.g. raw materials, wages etc.
• Implicit costs


  The opportunity costs of production, the cost of the next best alternative to employing the firm's resources
• Implicit costs must be considered as entrepreneurs will rationally reallocate resources when greater profits can be made elsewhere
• Profit calculation


  Profit = total revenue (TR) - total costs (TC)
• Total costs include explicit and implicit costs
• When the selling price (average revenue) is higher than the average variable cost (AVC)

  The firm should keep producing
• When the selling price (average revenue) falls to the AVC

  The firm should shut down
• A firm should shut down in the short-run if the selling price (AR) is unable to cover the AVC