Types of Cost, Revenue And Profit, Short-Run And Long-Run Production (Copy)
7.5 Types of Cost, Revenue and Profit, Short-Run and Long-Run Production
7.5.1 Short-Run Production Function
- Fixed Factors: Inputs that cannot be changed in the short run (e.g., factory size, machinery).
- Variable Factors: Inputs that can be adjusted in the short run (e.g., labour, raw materials).
Product Measures:
- Total Product (TP): Total output produced by given inputs.
- Average Product (AP): Output per unit of a factor.
Formula: AP = TP ÷ Quantity of input. - Marginal Product (MP): Extra output from one additional unit of a factor.
Formula: MP = ΔTP ÷ ΔInput.
Law of Diminishing Returns (Law of Variable Proportions):
- Adding more of a variable factor to fixed factors will eventually lead to a decline in MP.
Example Table – TP, AP, MP:
| Labour (units) | TP | AP | MP |
|---|---|---|---|
| 1 | 20 | 20 | 20 |
| 2 | 45 | 22.5 | 25 |
| 3 | 65 | 21.7 | 20 |
| 4 | 80 | 20 | 15 |
| 5 | 90 | 18 | 10 |
7.5.2 Short-Run Cost Function
- Fixed Costs (FC): Do not vary with output (e.g., rent).
- Variable Costs (VC): Vary with output (e.g., raw materials).
- Total Cost (TC) = FC + VC.
- Average Cost (AC) = TC ÷ Q.
- Marginal Cost (MC) = ΔTC ÷ ΔQ.
- Average Total Cost (ATC) = AFC + AVC.
- Average Fixed Cost (AFC) = FC ÷ Q.
- Average Variable Cost (AVC) = VC ÷ Q.
Shape of Curves:
- MC curve is U-shaped due to diminishing returns.
- ATC and AVC also U-shaped; AFC declines continuously.
Example Table – Cost Measures:
| Q | FC | VC | TC | AFC | AVC | ATC | MC |
|---|---|---|---|---|---|---|---|
| 1 | 100 | 50 | 150 | 100 | 50 | 150 | – |
| 2 | 100 | 90 | 190 | 50 | 45 | 95 | 40 |
| 3 | 100 | 120 | 220 | 33.3 | 40 | 73.3 | 30 |
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Economics Full Scale Course
7.5.3 Long-Run Production Function
- No fixed factors — all inputs are variable.
- Returns to Scale:
- Increasing returns to scale: Output ↑ by greater proportion than inputs.
- Constant returns to scale: Output ↑ in same proportion as inputs.
- Decreasing returns to scale: Output ↑ by smaller proportion than inputs.
7.5.4 Long-Run Cost Function
- Long-Run Average Cost (LRAC) curve: U-shaped due to economies and diseconomies of scale.
- Minimum Efficient Scale (MES): Lowest output level at which LRAC is minimised.
7.5.5 Relationship Between Economies of Scale and Decreasing Average Costs
- Economies of scale → LRAC falls as output increases.
- Beyond MES → diseconomies of scale may set in, raising LRAC.
7.5.6 Internal and External Economies of Scale
| Type | Definition | Examples |
|---|---|---|
| Internal | Cost advantages within a firm as it grows | Bulk buying, technical efficiency |
| External | Cost advantages to all firms in an industry as industry expands | Skilled labour pool, shared infrastructure |
7.5.7 Internal and External Diseconomies of Scale
| Type | Definition | Examples |
|---|---|---|
| Internal | Rising costs within a firm as it grows | Management inefficiency, worker demotivation |
| External | Rising costs for all firms as industry expands | Resource shortages, higher input prices |
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Economics Full Scale Course
7.5.8 Revenue: Total, Average and Marginal
- Total Revenue (TR) = Price × Quantity.
- Average Revenue (AR) = TR ÷ Q (equals price in perfect competition).
- Marginal Revenue (MR) = ΔTR ÷ ΔQ.
Example Table – Revenue Measures:
| Q | P | TR | AR | MR |
|---|---|---|---|---|
| 1 | 50 | 50 | 50 | – |
| 2 | 48 | 96 | 48 | 46 |
| 3 | 46 | 138 | 46 | 42 |
7.5.9 Profit Types
| Type | Definition | Condition |
|---|---|---|
| Normal Profit | Minimum profit to keep resources in current use | TR = TC |
| Subnormal Profit | Profit less than normal, loss-making | TR < TC |
| Supernormal Profit | Profit above normal | TR > TC |
7.5.10 Calculation of Supernormal and Subnormal Profit
- Supernormal: TR − TC > 0.
- Subnormal: TR − TC < 0.
Example:
- TR = $1,000, TC = $800 → Supernormal profit = $200.
- TR = $700, TC = $800 → Subnormal profit = −$100 (loss).