1. 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 output (product)
Marginal Costs – cost of one additional unit of output

2. Italian Taste… make a list of their fixed and variable costs

3. Three Types of Costs
Cost
Total Cost
Variable Cost
Fixed Cost
Output

4. Production Costs Output Fixed Cost Variable Cost Total Cost
Average Cost
Marginal Cost 40
---- 5 20 10 7 15 90 50

5. 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.

6. Long Run vs. Short Run AC
Short Run: time period in which at least one factor of production is fixed
Long Run: time period in which all factors of production can be varied
Cost £
SRAC1
LRAC
Economies of Scale: - decreases in LRAC from increased scale of production
SRAC2
SRAC3
Quantity

7. Let’s talk about revenue…
How do we calculate total revenue?
How do we calculate revenue per unit?
How do we calculate average revenue?
What happens to price as firms try to sell more units?
What happens to total revenue as firms try to sell more units?
Can you draw a curve for any of these ideas?

8. Revenue Curves?

9. 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)
MR drops 2x as fast as AR, because as output is increased and price is dropped, all the people who might have paid 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.
Price £
AR = D
Quantity MR

10. How does total revenue relate to this diagram…

11. How does total revenue relate to this diagram…
Price AR MR + - TR
Q Rev Max
Quantity

12. A firm will “maximise” profit where: MC = MR
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

13. MC = MR
Price £ MC
Quantity MR

14. Profit Concepts
Normal Profit: profit required to keep a firm in business (they will close / ‘exit the industry’ if not making ‘normal profit’ in the long run)
Since ‘normal profit’ is required, economists include it in the cost curves of the company
So ‘normal profit’ is achieved where AR = AC

15. Profit Concepts
Supernormal Profit: profit over and above ‘normal profit’ AR › AC
Loss: normal profit is not being earned AR ‹ AC

16. Shut-down Point
Firms may not want to or be able to go out of business if they start making a loss…
Why?

17. Shut-down Point
Firms may wish to stop producing, whilst remaining in business
Or they may wish to continue producing, even if they are making a loss
The point at which they decide to stop producing is called the ‘shut down point’
Where AR = AVC
If AR › AVC, the firm will keep producing
If AR ‹ AVC, the firm will ‘shut down’

18. 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
Increasing Returns
Output 20%
Input 10%
Decreasing or Diminishing Returns
Output 10%
Input 20%

19. 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)
Dynamic Efficiency: optimisation from changing production techniques (new technology, building on expertise) – can lower SRAC and LRAC
X Inefficiency: bureaucracy & complacency of firm with too much market power → higher costs

20. 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