Microeconomics

• Short Run Definition

  At least one factor of production is fixed (e.g capital). Output can onle be increased by increasing quantity of a variable factor (e.g labour)
• Total, average and marginal products

  total product - total quantity of outputs produced by a given number of inputs and time period

  average product - total product/no. of workers

  marginal product - the addition to total output produced by an extra unit (employer)

  NOTE: product = returns = output
• Law of Diminishing Marginal Returns

  As variable factors (workers) are added, the marginal output falls

  
  

  Initially, there is increasing marginal returns as:

  1. specialisation
  2. teamwork

  However as optimum capacity limits are approached, eventually each additional unit of labour employed adds less to total output than the previous one, due to:

  1. workers queuing for equipment
  2. workers getting in each others way

  This will also lead to rising marginal costs, and marginal returns eventually become negative leading to a fall in total returns, total output falls
• Relationship between MP and AP curves

  When MP>AP, pulls AP up

  When MP<AP, drags AP down

  therefore MP cuts AP at its highest point

  
• Fixed Costs


  Fixed costs are costs that remain constant as output increases e.g business rates, rent, insurance

  Average fixed costs fall continuously as output increases because total fixed costs are being spread over a higher level of production

  
• Variable Costs


  Costs which vary directly with output e.g raw materials and labour

  Real world

  costs rise at a slower rate initially - specialisation + teamwork

  costs rise at a faster rate - DMC reasons

  
• Total Cost


  TC = FC + TVC

  
• Marginal and Variable Cost Curves

  NOTE: marginal - tick shape

  variable - u shape

  As marginal costs are the addition to total costs, they are the same as variable costs eg raw materials

  
• Cost Formulas


  Marginal Cost MC is change in Total Cost/change in output

  Average costs AC - total cost / output

  Average variable costs AVC - total variable costs / output

  Average fixed costs AFC - total fixed costs / output

  Average total cost - AVC + AFC
• Revenues - Def and Formula

  TR - total amount of money received from sale of an output

  TR - Price x Quantity

  AR - average per unit sold

  AR - TR/Quantity

  MR - additional revenue from selling one extra unit of output

  MR - changeTR/changeQuantity
• Revenue Curves


  Diagram 1 - Average and Marginal Revenue

  AR follows same rules as demand curve

  MR goes under graph as it becomes negative due to law of diminishing returns

  Diagram 2 - Total Revnue

  past Q1 TR falls as MR becomes negative (law of DMR)

  
• Profits 


  Profit = TR - TC

  Normal profits = amount of profits required to keep resources in their present use

  Abnormal profits = profit over and above normal profit

  NOTE: TC = TR does not mean zero profits/break even
• Long run


  All quantity of all factors of production can be varied (capital)

  e.g output can be released by moving to a new scale of production (new factory/equipment)
• Internal Economies of Scale

  Shows the reduction in unit costs as a result of an increase in scale of factors of production, and therefore generates cost advantages.
• Internal economies of scale types

  Technical economies

  • specialist machinery
  • law of increased dimensions

  Marketing economies

  • strong bargaining/monopsony power over suppliers and workers
  • marketing - cost of advertisement is fixed
  • bulk buying

  Labour economies of scale

  • specialisation
  • managerial economics

  Financial economies

  • larger firms will likely have a better credit rating, therefor can obtain loans more frequently and cheaply as they are lower risk
• Econonies of scale diagram

  The minimum efficient scale is where the internal economies of scale have been fully exploited abd is where productive efficiency occurs

  
• Envelope Curve

  • Each SRAS curve represents a different factory/scale of operation
  • falling LRAS - economies of scale
  • rising LRAS - diseconomies of scale
  • MES is the scale of production where economies of scale have been fully exploited

  
• Internal Diseconomies of Scale

  leads to a rise in firm's LRAC, results from firms expanding beyond optimum size and losing productive efficiency, resulting in rise in price levels

  Control and Communication - may find problems in monitoring productivity and work quality, wastes resources and increases costs

  Co-operation - workers may feel alienated and a loss of morale, thus affecting productivity and wastage, leading to higher AC
• External economies of scale

  Fall in average cost due to being part of an industry
• Labour


  • Concentration of workers in a specific area leads to a large pool of skilled workers
  • Fall in recruitment and average costs
• Specialist Suppliers


  • It becomes profitable for some firms to specialise into making components for larger firms
  • They locate close to the centre of manufacturing
  • Fall in delay/distribution costs
• Cooperation


  • Firms in the same industry may share and diffuse innovation with each other
• Transportation


  • Transportation network may benefit firms via improved delivery system
  • Fall in transport and average costs
• Types of external economies of scale (1)

  Labour - Concentration of workers in a specific area can lead to a large pool of skilled workers. Recruitment costs are reduced - fall in AC

  Specialist Suppliers - It may become more profitable for firms in other industries to specialise making components for the larger one. Firms tend to be close to centre of manufacturing - fall in delay/distribution costs - fall in ac
• Types of external economies of scale (2)

  Co-operation - Firms may cooperate if concentrated - fall in ac’s

  Transportation - Good transportation network benefits firms via improved delivery system - fall in distribution costs - fall in ac’s
• Minimum efficient scale (MES)

  the scale of production where the internal economies of scale have been fully exploited, it's the point of productive efficiency in the long run
• External Disecononies of Scale Diagram

  External Diseconomies are rising long run that result from being part of an industry (geographical concentration). Causes shifts in LRAC curve and other increases costs of production for all firms in the industry

  
• 3 examples of external diseconomies of scale


  . Local Labour becomes scarce and firms have to offer higher wages to attract and retain new workers

  . Local roads are congested so transport costs begin to rise

  . Land and factories become scarce and rents begin to rise
• Advantages of EOS


  . Economies of scale lead to lower unit costs which can be passed onto consumers in the form of lower prices

  . Higher sales and profits can be reinvested into R&D, leading to new products and dynamic efficiency
• Disadvantages of EOS


  . Firms may not reduce prices and instead take a higher profit margin instead

  . Market demand may be insufficient for economies of scale to be fully exploited

  . Businesses may use EOS to build monopoly power, which may lead to higher prices and a fall in consumer welfare

  . EOS may be used as a barrier to entry and drive down prices to squeeze out smaller firms, limiting competition

  . In 2017 Uber was the most loss making private company in tech history suggesting EOS have not led to profits yet
• AO4 Economies of Scale

  . Firms may become so big that they suffer diseconomies of scale, however DOS may likely be offset by significant economies (e.g car manufacturing)

  . Nature of production may influence size of MES relative to market demand, may be very small (e.g hairdressing vs aircraft)

  . Small businesses can still survive even if industries dominated by large businesses (niche products)

  . May or may not accelerate R&D and innovation, as smaller firms may be squeezed out by larger firms and limit innovation