Revenue cost profit

• Shareholders will seek to maximise their utility by maximising profits – profit maximisation occurs when marginal revenue (MC) is equal to marginal costs (MR) – so Profit max is where MC = MR. However, some firms may find they are making a loss at this position.
• Managers will also want to maximise their utility, which is often linked to the amount of sales they achieve. So, they will want to operate at a sales maximising position (maximum number of sales possible while still breaking even)- this point is where Average Revenue (AR) is equal to Average Costs (AC) – so Sales max is where AR = AC.
• Revenue maximisation is where the business makes their absolute maximum revenue, and occurs where Marginal Revenue = 0. (where the MR curve crosses the bottom of the diagram)
• ·     Total revenue = Price x Quantity

  ·     Average Revenue = total revenue  ÷ quantity

  ·     Marginal revenue = change in revenue  ÷ change in quantity
• When demand is elastic, increasing price will reduce total revenue and decreasing price will increase total revenue

  When demand is inelastic, increasing price will increase total revenue and decreasing price will reduce total revenue
• ·     Total costs = total fixed costs x total variable costs

  ·     Total variable costs = variable cost x quantity

  ·     Average (total) cost = total cost  ÷ quantity

  ·     Average fixed cost = total fixed cost  ÷ quantity

  ·     Average variable cost = total variable cost  ÷ quantity

  ·     Marginal cost = change in cost  ÷ change in quantity
• Increases in output are limited by Diminishing returns. This is because in the short run, at least one factor of production if fixed. When you increase one factor of production by one unit but keep the others fixed, the extra output you get is called the marginal product (aka marginal returns)
• Initially as you add more of a factor of production, the marginal product will increase. This is because each unit of input added will add more ouput than the one before (because of specialisation and division of labour). Eventually, if you keep adding units, the fixed factor of production will begin to limit the additional output. (For example, if there is only 1 large machine with 3 buttons, the 4th worker added will provide less output than the previous 3 workers because there is no space or capital for him).
• Economies of Scale (Internal)


  The cost advantages of production on a larger scale
• Purchasing

  • Larger firms will need larger quantities of raw materials, so can often negotiate discounts with suppliers because they are the most important customers
• Marketing

  • Advertising is usually a fixed cost, which is spread over more units as a firm grows, so the cost per unit is lower
  • Larger firms may also benefit more from brand awareness, so it will be trusted by consumers. This might mean the large firm doesn't have to advertise as much to get sales
• Technical

  • Larger firms may purchase specialised equipment to lower average costs
  • Workers can also specialise / divide labour which may not be possible in a small firm
• Financial


  • Larger firms can often borrow money at a lower rate of interest as banks see them as less risky
• Managerial

  • Large firms will employ specialist managers to take care of different areas of their business
  • These managers gain experience and expertise in that area, leading to better decision making
  • Management costs per unit will also be lower because no matter how much it grows, there will only be 1 manager for that area
• Risk Bearing

  • Larger firms can often diversify into different product areas and different markets (e.g. different countries)
  • This diversification leads to lower risk because if one section fails, there are other areas which can absorb the losses
• Economies of scale (External)

  Local colleges may start to offer qualifications needed by big local employers, reducing the firm’s training costs. Large companies locating in an area may lead to improvements in road networks or local public transport. If lots of firms doing similar things locate near each other, they may be able to share resources (e.g. research facilities). Suppliers may also decide to locate in the same area, reducing transport costs.
• Diseconomies of scale


  • Internal
  • External
• Internal diseconomies of scale

  • Wastage and loss can increase as supplies seem plentiful. Bigger warehouses may lead to things getting lost or mislaid.
  • Communication may become more difficult or bureaucratic, affecting staff morale.
  • Managers may find it more difficult to control what is going on.
  • It becomes more difficult to coordinate activities between different divisions and departments
  • A 'them and us' attitude can develop between different departments, leading to people putting their department's interests before the company's, leading to less cooperation and efficiency.
• External diseconomies of scale

  • As a whole industry becomes bigger, the price of raw materials may increase because demand will be greater
• Normal Profit – A firm is making normal profit when its total revenue is equal to its total costs. So, normal profit is the minimum level of profit needed to keep resources in use in the long-run (they can make a loss in the short run).
• Supernormal profit – A firm is making supernormal profit when its total revenue is greater than total costs. If firms in an industry are making supernormal profits, this will create an incentive for other firms to try and enter that industry (unless it is a natural monopoly with extreme barriers to entry).
• A firm not making normal profit will not be able to survive in the long run because its revenue is not covering all of its costs. However, in the short run, a firm has fixed costs that it still has to pay whether or not it produces any output. So, a loss-making firm may not close immediately, it depends how it’s revenue compares to the variable costs.
• If the total revenue is greater than total variable costs, it will continue to produce in the short run. This is because every unit they sell will be contributing to paying their fixed costs. If they stop, they will actually be worse off.
• if the total revenue is lower than total costs (i.e. the cost of raw materials and labour is higher than the selling price), every unit they sell is making them worse off.