Section 3 - Business Economics Flashcards
Production
> Production means manufacturing something in order to sell it.
Production involves converting inputs (e.g. raw materials, labour) into outputs (things to sell).
Input
> The inputs can be any of the four factors of production - land, labour, capital and enterprise.
Inputs can be tangible or intangible.
Tangible
> Things you can touch, like raw materials or machines.
Intangible
> ‘Abstract’ things that can’t be touched - like ideas, talent or knowledge.
Output
> The outputs produced should have an exchangeable value - they need to be something that can be sold.
Productivity
> Productivity is a way of measuring how efficiently a company or an economy is producing its output.
It’s defined as the output per unit input employed. So if one company could take the same amount of inputs as the other company, but produce more stuff, their productivity would be greater.
You can work out overall level of productivity (involving all four possible inputs) or productivity f any one of the four individual factors of production.
Improving productivity of any one of these separate factors should increase overall production.
Labour productivity - definition
> Output per worker or per hour worked.
Labour productivity - how to calculate
- Take the amount of output produced in a particular time.
2. Divide this by the total number of workers (or per worker-hour).
What does labour productivity allow?
> Labour productivity allows workers to be compared against other workers.
E.g. labour productivity is calculated for whole economies, so that the productivity of different labour forces can be compared.
How can labour productivity be improved?
- Better training.
- More experience.
- Improved technology.
>Specialisation can also improve labour productivity - if each worker performs tasks that they are good at doing, have practised a lot and have been trained to do, then they’ll produce more than if they did lots of different tasks.
Specialisation
> Division of labour is a type of specialisation where production is split into different tasks and specific people are allocated to each task.
Adam Smith explained the increase in productivity that could be achieved through the division of labour. He said that one untrained worker wouldn’t even make 20 pins a day, but 10 workers, specialising in different tasks could make 48,000.
There are advantages and disadvantages of specialisation, but overall an economy can produce more stuff if people and firms specialise.
It’s not just individuals and firms that can specialise - whole regions and even countries can specialise to an extent. E.g, there are loads of technology companies based in Silicon Valley in California.
Advantages of specialisation
- People can specialise in the thing they’re best as or by doing it, they learn to become better at it.
- This can lead to better quality and a higher quantity of products for the same amount of effort overall i.e. - increased labour productivity.
- Specialisation is one way in which firms can achieve economies of scale e.g. a production line (where each person may perform just one or two tasks) is a form of specialisation.
- Specialisation leads to more efficient production - this helps to tackle the problem of scarcity, because if resources are used more efficiently, more output can be produced per unit of input.
- Training costs are reduced if workers are only trained to perform certain limited tasks.
Disadvantages of specialisation
- Workers can end up doing repetitive tasks, which can lead to boredom.
- Countries can become less self-sufficient - this can be a problem if trade is disrupted for whatever reason (e.g. a war or dispute). E.g. if a country specialises in manufacturing, and imports (rather than producing) all its fuel, then that country could be in trouble if it falls out with its fuel supplier.
- It can lead to a lack of flexibility - e.g. if the companies eventually move elsewhere, the workforce left behind can struggle to adapt.
Link between trade and specialisation
> Specialisation means that trade becomes absolutely vital - economies (and individuals and firms) have to be able to obtain the things they’re no longer making for themselves. This means it’s necessary to have a way of exchanging goods and services between countries.
Trade
> Swapping goods with other countries is one way a country can get what it needs.
This way of trading goods is called a barter system - it’s very inefficient because it takes a lot of time and effort to find traders to barter with.
The most efficient way of exchanging goods and services between countries is using money (with the use of exchange rates where necessary).
Money - definition
> Money is a medium of exchange - it’s something both buyers and sellers value and that means that countries can buy goods, even if sellers don’t want the things that the buying country produces.
Money’s other functions
> Money has 3 other functions too:
- A measure of value - e.g. the value given to a good can be measured in US dollars.
- A store of value - e.g. an individual who receives a wage may wait before buying something if they know that the money they have will be of similar value in the future.
- A standard (or method) of deferred payment - money can be paid at a later date for something that’s consumed know, e.g. people often borrow money to buy a car or pay university fees.
Firms - definition
> A firm is any sort of business organisation, like a family-run factory, a dental practice or a supermarket chain.
Industry - definition
> An industry is all the firms providing similar goods or services.
What do markets contain?
> A market contains all the firms supplying a particular good or service and the firms or people buying it.
Firms
> Firms generate revenue (money coming in) by selling their output (goods or services).
Producing this output uses factors of production, and this has a cost.
The profit a firm makes is its total revenue minus its total costs.
In the long run firms need to make profit to survive.
What do economists include in the cost of production?
> Opportunity cost.
Economists and the cost of production
> When economists talk about the cost of production they are referring to the economic cost of producing the output.
The economic cost includes the money cost of factors of production that have to be paid for, but also the opportunity cost of the factors that aren’t paid for (e.g. a home office that a business is run from).
The opportunity cost of a factor of production is the money that you could have got by putting it to its next best use.
E.g. if you run your own business the money you could earn doing other work is the opportunity cost of your labour.
So, in economics, cost isn’t just a calculation of money spent - it takes into account all of the effort and resources that have gone into production.
The opportunity cost of a factor of production
> The opportunity cost of a factor of production is the money that you could have got by putting it to its next best use.
E.g. if you run your own business the money you could earn doing other work is the opportunity cost of your labour.
Short run
> The short run is the period of time when at least one of a firm’s factors of production is fixed.
The short run isn’t a specific length of time - it varies from firm to firm.
E.g. the short run of a cycle courier service could be a week because it can hire new staff with their own bikes quickly, but a steel manufacturer might have a short run of several years because it takes lots of time and money to build a new steel-manufacturing plant.
Costs can be fixed or variable.
Long run
> The long run is a period of time when all factors of production can be varied.
In the long run all costs are variable.
What can costs be in short run?
> Fixed or variable.
Fixed costs
> Fixed costs don’t vary with output in the short run - they have to be paid whether or not anything is produced.
E.g. the rent on a shop is a fixed cost - it’s the same no matter what the sales are.
Variable costs
> Variable costs do vary with output - they increase as output increases,
The cost of the plastic bags that a shop gives to customers is a variable cost - the higher sales are, the higher the overall cost of the bags.
Total cost
> The total cost (TC) for a particular output level is the total fixed costs (TFC) plus the variable costs (TVC) for that output level:
TC = TFC + TVC.
Average cost
> Average cost (AC) a.k.a. average total cost (ATC) is the cost per unit produced.
AC is calculated by dividing total costs by the quantity produced (Q): AC = TC/Q.
Average fixed cost (AFC) = TFC/Q.
Average variable cost (AVC) = TVC/Q.
Marginal cost - definition
> Marginal cost (MC) is the extra cost incurred as a result of producing the final unit of output.
Marginal cost
> Marginal cost is only affected by variable costs - fixed costs have to be paid even if nothing is produced.
You can calculate it by finding the difference between total cost at the current output level (TCn) and total cost at one unit less (TCn-1):
MC = TCn - TCn-1.
More general formula for MC
MC = Change in TC / Change in quantity.
Trend of MC
> Marginal cost decreases initially as output increase, then begins to increase in the short run because of the law of diminishing returns.
So the MC curve is always u-shaped.
Changes in MC affect average cost.
How does MC affect AC?
- When the MC is lower than the AC, the AC will be falling. This is because each extra unit produced will decrease the average cost (adding something smaller than the average will decrease the average).
- When the MC is higher than the AC, the AC will be rising because each extra unit produced will increase the average cost.
- So the MC curve meets the AC curve at the lowest AC, i.e. AC will be lowest when MC = AC - this is the point of productive efficiency.
Other than the average cost curve, which other curve does the marginal cost curve cross?
> The MC curve also meets the AVC curve at the minimum AVC.
Marginal cost is made up of variable costs, so it increases and decreases AVC in the same way it does AC.
This means AVC and AC curves also always form a u-shape in the short run - they both decrease until they reach a a minimum, then begin to increase.
AFC Curve
> AFC falls as output rises because the total fixed cost is spread across the greater output.
What are increases in output limited by in the short run?
> Diminishing returns.
What does the law of diminishing returns explain?
> The law of diminishing returns explains what happens when a variable factor of production increases while other factors stay fixed. Because at least one factor stays fixed, the law of diminishing returns only applies in the short run.
When you increase one factor of production by one unit, but keep the others fixed, the extra output you get is called the marginal product.
E.g. if you add one more unit of labour, the extra output is the marginal product of labour.
Marginal product - definition
> Marginal product (MP) is the additional output produced by adding one more unit of a factor input.
I.e. by adding one more unit of any of the factors of production being used.
Another term for marginal product is marginal returns.
Increasing output - MP and law of diminishing returns explaination
- Initially, as you add more of a factor of production the marginal product will increase - each unit of input added will add more output than before.
- This might happen because more specialisation is possible with more of a particular factor. As more people are employed, for example, they can specialise in carrying out particular tasks.
- Eventually, if you keep adding units of one factor of production, the other fixed factors will begin to limit the additional output you get, and the marginal product will begin to fall. E.g. if a clothes manufacturer only has 5 sewing machines, employing a 6th machinist will probably add less output than employing the 5th did, and employing a 7th will add even less.
>This is the point of diminishing returns - the point where marginal product begins to decrease as input increases.
Law of diminishing returns - key
> If one variable factor of production is increased while other factors stay fixed, eventually the marginal returns from the variable factor will begin to decrease.
Law of diminishing returns says..
Plus other names
> The law of diminishing returns says that there is always a point where marginal product begins to decrease.
Law of diminishing marginal returns.
Law of variable proportions.
What does marginal returns do to marginal cost?
> Increases it.
Marginal returns or marginal product - relation to marginal cost
> MP is related to the marginal cost.
As marginal returns rise, marginal cost falls.
As marginal returns fall, marginal cost rises.
The MC curve is a mirror image of the MP curve.
MC will rise as marginal returns fall because, ceteris paribus, if you’re getting less additional output from each unit of input then the per unit of that output will be greater.
What does diminishing marginal returns eventually cause?
> Productivity to fall
Diminishing returns and productivity
> The Law of diminishing returns says that as the level of a variable factor input is increased, MP will eventually begin to diminish.
As the level of that factor input continues to be increased, the average product will eventually start to fall too. The MP curve always meets the AP curve when AP curve is at its max.
The average product is also known as productivity.
E.g. if the variable factor is labour, the labour productivity would be the average output per worker. So if a firm employs more and more people, it will eventually find that the productivity of those employees falls.
If you keep adding more of the variable factor, you can even reach a stage where adding further input results in a fall in the total product. (MP becomes negative).
