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

2. 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

3. 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!

4. 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.

5. Answers…..
Did you get this????

6. And this (profit making business!)

7. And this … a loss making business..

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

9. 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

10. 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

11. 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.

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

13. 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!

22. Can you list me ….
Fixed costs
Variable costs

23. There were a few diagrams you need to know

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

25. Did it look like this?

26. 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

27. 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

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

29. 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!

30. An important economic concept…
Diminishing Returns
An important economic concept…

31. 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’!

32. 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!

33. 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.

34. 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

35. 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!

36. 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.

37. 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!

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

39. 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

40. Demand curve…
Price P1
Demand Q1
Output

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

42. 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

43. 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 `

44. Optimum sales…

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

46. 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

47. 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

48. 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

49. 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.

50. 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….

51. 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

52. 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

53. 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!

54. 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!

55. 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

56. Profit maximisation
MR = MC

57. So … do you think you missed much?

58. Your task…
3 Multi choice Q’s

59. Answer
Reason:

61. Answer
Reason:

63. Reason
Answer

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

66. Questions: