Parent’s evening appointments Fill in the sheet – this should be your ONLY parent’s evening of the year!

Miss any lessons during summer term? Did you miss much? This has 50 of the VITAL slides from the 5 of 8 lessons last term

And lots of NEW diagrams! What is Unit 3 all about? The Objectives of Firms The Divorce of Ownership from Control The Law of Diminishing Returns and Returns to Scale Fixed and Variable Costs, Marginal, Average and Total Costs, Short-run and Long-run Costs Economies and Diseconomies of Scale Technological Change, Costs and Supply in the Long-run Total, Average and Marginal Revenue Profit And lots of NEW diagrams!

So Quick Test!..... 2 diagrams to draw! Draw me a diagram to show a company that’s making supernormal profit. Label all parts clearly. Draw me a diagram to show a company that’s making a loss. Label all parts clearly.

Answers….. Did you get this????

And this (profit making business!)

And this … a loss making business..

You should remember that there are 2 types of costs…. Business costs You should remember that there are 2 types of costs….

Fixed Costs In the short run, because at least one factor of production is fixed, output can be increased only by adding more variable factors Hence we make a distinction between fixed and variable costs Fixed costs are also known as the overhead costs of a business

Fixed Costs Fixed costs These do not vary directly with the level of output i.e. they are treated as independent of production Examples of fixed costs include the rental costs of buildings, equipment such as plant and machinery, the costs of full-time contracted salaried staff, the costs of meeting interest payments on loans, the depreciation of fixed capital (due solely to age) and also the costs of business insurance Fixed costs are also known as the overhead costs of a business

Variable Costs Variable costs are business costs that vary directly with output. Examples of variable costs include the costs of intermediate raw materials and other components, the wages of part-time staff or employees paid by the hour, the costs of electricity and gas and the depreciation of capital inputs due to wear and tear.

We looked at Amazon warehouse And many other businesses! Farmers, Jamie Oliver’s 15 restaurant, Channel Tunnel, Royal Mail, Google etc

Factor inputs – a case of Amazon… Look closely at the next 8 slides – I’ll run through them twice! At the end you will be asked to identify items that will be FIXED and VARIABLE within the business!

Can you list me …. Fixed costs Variable costs

There were a few diagrams you need to know

Using your whiteboard Can you draw me the main business economic diagram?

Did it look like this?

Fixed Cost Curves Costs Total Fixed Cost Output Fixed costs (FC) are totally independent of output and must be paid out even if the production stops. Capital intensive industries with a high ratio of fixed to variable costs offer scope for economies of scale AFC = Fixed Costs (FC) / Output (Q). Output

Fixed Cost Curves Why does the AFC curve? Costs Total Fixed Cost Average fixed costs must fall continuously as output increases because fixed costs are being spread over a higher level of production. In industries where the ratio of fixed to variable costs is extremely high, there is great scope for a business to exploit lower fixed costs per unit if it can produce at a big enough size Average Fixed Cost Output

Short run V Long run Its all about CELL being varied or not! Long run – even capital goods can be increased!

Sunk Costs Short run FC aka…Sunk costs… once you already own a fixed cost – it’s useless trying to include this when deciding what price to sell your product at – since it’s money already spent! Whether you use the FC item (equipment) or not – the money spent is historic and can’t be reclaimed – if you sell the item it’s definitely depreciated! Might as well let it sit idle than sell…. Might need it in the future!

An important economic concept… Diminishing Returns An important economic concept…

Diminishing returns…. It’s such an important aspect…. When you have 1 FoP that’s fixed in the SR (usually land) and when you increase another FoP (usually labour) – then there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit. i.e. you can have too many workers as there is not enough space or equipment for them to operate effectively & so ‘do less’!

Diminishing returns & Churchill! Churchill related diminishing returns theory to his strategy in WW2…there is an optimal point of bombing Germany – any extra bombs just moved around war damage!

Diminishing returns & car seats Think about a seat belt – 1 give a lot of safety…. A 2nd give a bit more but a third is just silly and gives no extra protection – just v uncomfortable – a 4th would hurt! There is no additional safety gained from more seatbelts being used.

Marginal and Average Physical Product Optimum output when MPP = APP While MPP rises Then APP also rises When MPP is lower than APP then APP also falls

Variable costs It’s not a straight VC line (like in BS theory!) VC depend on The productivity of the factors – some VC’s will have greater or lesser ‘diminishing returns’! Some VC will have greater physical productivity – smaller quantities will produce a greater level of output (and vice versa!) The price of the factors – the higher their price the higher their costs!

Formulas needed…. Q TVC + TFC = TC AC = TC MC = TC  Q Average is the total divided by quantity Marginal is the cost of producing an extra unit of output.

Short run…. and ‘wobbly’ VC/TC curves Very different to BS Theory! Why do the curves ‘wobble’???? In the short run – FC & VC will rise MORE SLOWLY than output, BUT once diminishing returns set in – these costs will accelerate!

Exam favourites They appear to like setting one of the MC Q’s on MC/AC/TC

Total Revenue… Total revenue = income generated from sales (price * quantity sold) TR = P * Qty How can you see this on a D curve???? Draw a simple D curve – select Qty output and dot on price sold … so TR is equal to the ‘square’ of shading

Demand curve… Price P1 Demand Q1 Output

Total revenue = P x Qty… Price P1 Demand Q1 Output

Revenue concepts Revenue (or turnover) is the income generated from the sale of output in product markets. There are two main revenue concepts to grasp at this stage: Average Revenue (AR) = Price per unit = total revenue output Marginal Revenue (MR) = the change in revenue from selling one extra unit of output Total revenue (TR) = price per unit x output

Calculating AR & MR What would you recommend as their max sales qty? What would this look like as a line diagram? Why is this also the ‘price’? output AR TR MR 1 30   2 27 54 24 3 72 18 4 21 84 12 5 90 6 15 7 -6 8 9 -12 -18 10 -24 `

Optimum sales…

Average Revenue… How do you calculate average revenue? AR = TR = or = (P * Q) Q Q so AR =P So AR = D curve!!!!

What happens if Prices are lowered? Average Revenue What happens if Prices are lowered? Revenue P1 Average revenue P2 A downward sloping average revenue curve means that a business must cut the price per unit to sell extra units. Clearly the extent to which price needs to change to lead to an expansion of demand depends on the price elasticity of demand Q1 Q2 Output

How does a business decide on the ‘optimum’ price to charge? Average Revenue How does a business decide on the ‘optimum’ price to charge? Revenue P1 Lost revenue from lower price Average revenue P2 Increased revenue from selling more Q1 Q2 Output

Marginal & Average Revenue It depends on the ‘marginal’ revenue Revenue P1 Average revenue P2 The marginal revenue curve depends on the slope of the AR curve. It is half of the AR curve with twice the gradient Marginal revenue Q1 Q2 Output

When diminishing returns set in (beyond output Q1) the marginal cost curve starts to rise. Average total cost continues to fall until output Q2 where the rise in average variable cost equates with the fall in average fixed cost. Output Q2 is the lowest point of the ATC curve for this business in the short run. This is known as the output of productive efficiency.

So why are diminishing returns important? The law of diminishing returns implies that the marginal cost of production will rise as output increases. This is why companies need to do MORE than just employ more workers if they want to meet objectives….

The profit maximising level of output Another diagram to learn! Need to add red lines on top to show TC and below to show MC (LRAC curve) The points where MC cut MR (twice) are the same where TC cut TR 1st and 2nd is th max gap!!! SEE BOOK p 305

Different types of profit Profit measures the return to risk when committing scarce resources to a market or industry In economics there are 3 different types of profit: Normal profit Sub-normal profit Abnormal profit

Normal Profits Normal profit - is the minimum level of profit required to keep the factors of production in their current use in the long run Normal profits reflect the opportunity cost of using funds to finance a business If you wanted to start up your own business and put £50,000 of your own money into its start up, then you would look at how much £50k would earn you in a fairly risk-free way in a bank or building society deposit account. You could look at the interest you’d earn on that £50k as the minimum rate of return that you need to make from your business investment in order to keep going in the long run! So your ‘normal’ profit must cover this opportunity cost of you running this business!

Sub-normal Profits Because we treat normal profit as an opportunity cost of investing financial capital in a business, we normally include an estimate for normal profit in the average total cost curve, thus, if the firm covers its ATC (where AR meets AC) then it is making normal profits. Sub-normal profit - is any profit less than normal profit (where price < average total cost) So in our example, if you invested £50k and could get 1% IR…. Your normal profit would have to be £500… so if you only earned £200 profit …. It’s profit but sub-normal!

Super-normal Profits Super normal or Abnormal profit - is any profit achieved in excess of normal profit - also known as supernormal profit So in our example, if your business earned £3000 profit this year…. It’s super normal

Profit maximisation MR = MC

So … do you think you missed much?

Your task… 3 Multi choice Q’s

Answer Reason:

Answer Reason:

Reason Answer

Homework Read article.. Micropayments & newspapers – Answer Q’s at end of article

Questions: