Theme 3

• Economies of scale

  • Helps firms decrease their costs of production (decreasing LRAC)
  • Allows firms to sell more goods and make more revenue
• Law of diminishing marginal returns

  A phenomenon that will affect the business in the short run, when there is at least one fixed factor of production
• Short run

  A period of time where there is at least one fixed factor of production, normally capital and land
• Variable factor of production

  Labor
• Law of diminishing returns

  Total or marginal product will initially rise and then fall when variable factors of production are added to fixed factors
• Marginal product

  The extra output when one more worker is employed

  MP = change in output/change in the quantity of labour
• Average product = Total product/ quantity of workers
• Marginal product curve cuts the average product curve at its highest point
• Relationship between total product, marginal product and average product

  Total product is maximized when marginal product is 0
• The Law of Diminishing returns states that as the number of workers increases, the output per worker decreases. As the number of workers increases, the MP and AP falls because one of the fop is fixed.

  
• Short-run

  A period of time when there is at least one fixed factor of production
• The short-run is not defined in terms of six months or one year, it is defined in terms of the variability of factors of production
• Factors of production in the short-run

  • Land
  • Capital
• In the long-run, all factors of production are variable
• Explicit costs


  Costs that require actual payment
• Implicit costs

  Opportunity cost, the profit a business could have made doing their next best alternative
• Explicit costs

  • Fixed costs
  • Variable costs
• Fixed costs

  Costs that do not vary with output
• Variable costs

  Costs that vary with output
• Total fixed costs

  Constant, does not vary with output
• Average fixed cost

  Total fixed costs (TFC)/ quantity
• Average variable cost

  Total variable costs divided by quantity
• Average cost = Total cost / quantity
• Marginal cost equation

  The change in total cost divided by the change in quantity
• Average costs

  Costs per unit of output
• Marginal costs

  Additional cost of producing one more unit
• Total fixed cost

  • Does not vary with output
  • Constant over a range of output
• Total variable cost

  • Influenced by the law of diminishing marginal returns
  • Initially increases at a decreasing rate as output increases
  • Then increases at an increasing rate as diminishing returns set in
• Law of diminishing marginal returns

  In the short run, as a variable factor (labour) is added to fixed factors, output initially increases at an increasing rate, then increases at a decreasing rate
• Adding variable factor (labour)

  • Initially leads to productivity gains and lower increase in variable costs
  • Then leads to diminishing returns and faster increase in variable costs
• Total cost

  Total fixed cost + Total variable cost
• The total cost curve follows the shape of the total variable cost curve, just shifted up by the amount of total fixed cost
• Long-run

  A period of time where all factors of production are variable
• Scaling up a business

  Increasing any of the factors of production: land, labor, capital, enterprise
• Returns to scale

  The change in output when factors of production are increased
• Long-run average cost curve

  • Shaped due to returns to scale
  • Consists of lots of different short-run positions joined up
• Parts of the long-run average cost curve

  • Increasing returns to scale
  • Constant returns to scale
  • Decreasing returns to scale
• Increasing returns to scale

  Percentage change of output is greater than percentage change of inputs
• Decreasing returns to scale

  Percentage change of output is less than percentage change of inputs
• Constant returns to scale

  Percentage change of output is equal to percentage change of inputs