Download Fundamental-Concepts-Unit

Cost Concepts
• Fixed Costs – costs that are independent of
level of output (eg. rent on land, advertising fee,
interest on loan, salaries)
• Variable Costs – costs that are directly linked to
the quantity of output (eg. raw materials,
electricity, shipping, wages)
• Average Costs – cost per unit of production
• Marginal Costs – cost of one additional unit of
output
Three Types of Costs
Cost
Total Cost
Variable Cost
Fixed Cost
Output
Production Costs
Output
Fixed
Cost
0
40
5
Variable
Cost
Total
Cost
---20
10
15
20
Average Marginal
Cost
Cost
7
90
50
Cost Curves
Price £
MC
AC
MC crosses AC at min. AC
Quantity
For the average to be falling, the next unit (marginal) must
be less than the average – so MC must be less than AC
while AC is falling, and greater than AC when AC is rising.
Long Run vs. Short Run AC
• Short Run: time period in which at least one
factor of production is fixed
• Long Run: all factors of production can be varied
Cost £
SRAC1
Economies of Scale:
- decreases in LRAC
from increased scale
of production
LRAC
SRAC2
SRAC3
Quantity
Revenue Curves
D = AR because
it represents all
the prices at
which
consumers are
willing to buy
different
quantities (at 40
units, the price
will be £10, so
this is also the
average
revenue if 40
units are sold)
Price £
AR = D
Quantity
MR
MR drops 2x as
fast as AR,
because as output
is increased and
price is dropped,
all the people who
were previously
paying a higher
price now pay the
lower price, so the
“extra revenue
from one extra
unit” is less than
the actual
revenue received
for that unit.
Profit Maximisation
A firm will “maximise” profit where: MC = MR
***MEMORISE THIS***
• Because… if adding one extra unit of production
adds more to revenue than to cost, it will increase
total profit and should be produced
• If adding one extra unit of production adds less to
revenue than it does to cost, it will reduce profit and
should not be produced
• Firms will produce up until the point where MC=MR
MC = MR
Price £
MC
Quantity
MR
Productivity Concepts - Returns
Output expands when more units of variable factors
(labour, raw materials) are added to fixed factors
(land and equipment)
Returns – a measure of how an increase in inputs
affects the total output - a comparison of percentages
Input 10%
Input 20%
Output 20%
Output 10%
Increasing Returns
Decreasing or
Diminishing Returns
Efficiency Concepts to Assess
Performance of Firms
• Productive Efficiency: firm operates at the
lowest possible average cost (bottom of AC
curve)
• Allocative Efficiency: firm sets price equal to
marginal cost (scarce resources are allocated
where they are most valued by consumers)
• X Inefficiency: bureaucracy & complacency of
firm with too much market power → higher costs
Concentration Ratios
• Used to measure “market concentration” –
what percentage of the market is
dominated by “x” number of firms?
• Eg. “5-firm concentration ratio by sales”
measure the total market share of the
largest five firms in the industry using their
sales numbers