1. Theory of the Firm : Revenue and Cost Functions Foundation Microeconomics Part 1 of 3

2. MARK CLEARY FOUNDATION MICROECONOMICS Photograph tutor

3. Key Concepts Costs: Fixed, Variable, Total, Average, Marginal Price taker, price maker Profit Profit maximisation

4. Theory of the Firm Costs: charges incurred for the use of resources. Short Run: at least one factor of production is fixed Long Run: all factors of production are variable. Fixed Costs: costs that are independent of the level of activity of the firm, has to be paid for regardless of whether or not it is used. E.g. Rent, Business rates

5. Fixed Costs

6. Costs Variable Costs: Rise with output No output = No V.C. E.g. raw materials, wages, transport Total Costs: the summation of all the firms costs. TC = TVC + TFC

7. Variable Costs

8. Costs VariableTotal OutputFixed CostCost (units)(£000) 06000 40600150750 80600300900 1306004501050 190600 1200 2606007501350 3106009001500 34560010501650 38060012001800 39060013501950 41060015002100

9. Total Costs Cost £ q TC TVC FC

10. Costs Average Total Cost: the firm’s average cost per unit produced. ATC = TC/Q Average Variable Cost: AVC = TVC/Q Average Fixed Cost: AFC = TFC/Q Marginal Cost :  TC/  Q

11. Cost Average fixed cost Marginal Cost Average Total Cost Average variable Cost Cost Functions Quantity

12. VariableTotalATCAVCAFCMC Output Fixed CostCost (units)£0 06000 4060015075018.83.8153.8 8060030090011.33.87.53.8 13060045010508.13.54.63.0 190600 12006.33.2 2.5 26060075013505.22.92.32.1 31060090015004.82.91.93.0 345600105016504.831.74.3 380600120018004.73.21.64.3 3906001350195053.51.515.0 410600150021005.13.71.57.5

13. Theory of the Firm 1: Revenue and Cost Functions End of Part 1

14. Revenue Total Revenue: total received from the sale of output; TR = Price x Quantity that is TR = P x Q Profit: the difference between income and expenses; π = Total Revenue – Total Costs Marginal Revenue: the additional income gained by selling one addition unit MR=  TR /  Q Average Revenue: the firm’s average revenue per unit sold; AR = TR/Q

15. Price Maker revenue curves: Total revenue £ £ q q Average revenue and marginal revenue D = AR MR

16. Price taker revenue curves: Total revenue £ £ q q P Average revenue and marginal revenue TR D = AR = MR

17. Theory of the Firm 1: Revenue and Cost Functions End of Part 2

18. Theory of a Firm: Profit Profit: the difference between income and expenses; π = TR - TC Normal Profit: covering all costs, without making a surplus; thus effective π = 0 Supernormal Profit: cover all costs and make a surplus; π > 0 Loss: Not able to cover costs; π < 0

19. £ Output Total Cost Total Revenue Profit Q*Q* Theory of a Firm: Profit

20. Profit Maximisation Profit Maximisation: the price and output levels that would yield the greatest profits. Occurs when; Marginal cost = Marginal Revenue If; MR > MC; can make more profit by producing more; thus raise output MR < MC; making a loss on additional units sold; thus reduce profit MR = MC; any change from this point will cause a reduction in profit; stay at this level of output

21. Profit Maximisation MR MC Costs/Revenues Quantity

22. Key Concepts Costs: Fixed, Variable, Total, Average, Marginal Price taker price maker Profit Profit maximisation

23. KEY CONCEPTS Economies of Scale Diseconomies of Scale Impact of technology on firms

24. Theory of a Firm: Economies of Scale Economies of Scale: cost advantages obtained due to business expansion. If a firm is experiencing an increase in economies of scale; as output increases average costs per unit decrease. Diseconomies of Scale: as output increases, average costs per unit increases

25. Output O Costs LRAC Economies of scale Constant costs Diseconomies of scale A typical long-run average cost curve

26. Economies of Scale Factors that can lead to Economies of Scale Indivisibilities - large scale production uses more efficient techniques – central office and other functions – minimum efficient size of production lines – Research and Development Specialisation - division of labour, especially production lines; specialised departments - accounts, personnel, production etc.

27. Economies of Scale Expansion of Capacity More scope to meet unexpected contingencies - better experience. Inventories are smaller % of production Creation of transport and distribution networks

28. Economies of Scale Financial Loans, market power, bulk buying of raw materials, advertising Improve contracts with suppliers Selling and Marketing Improved capital and experience for advertising Creation of brand images, improved brand awareness

29. Economies of Scale Sunk costs - once plant is installed, the opportunity cost of its continued use may be very low. This gives ‘larger’ existing producers a cost advantage over new entrants. Central management organisation is of the nature of a one-off cost Spreading of risk - multi-product firms, may be able to force down labour costs

30. Diseconomies of Scale Ineffective Management Poor Communication Lack of effective knowledge and lack of building on experience