Economies of Scale, Specialisatiion, Costs | 4.1.4 | Microeconomics | AQA A-Level Economics Notes

Last updated on Jan 9, 2024

4.1.4.1 Production and Productivity

Production is a process where inputs, such as factors of production, are converted into a final output.
Productivity is output per unit input per unit time.

4.1.4.2 Specialisation, Division of Labour and Exchange

Specialisation is when each region completes a specific task in a large production process. Division of Labour is specialisation by worker.
Pros: higher output, better quality of output, greater variety of goods produced, opportunities for economies of scale, more competition and therefore lower prices, lower average costs.
Cons: work is repetitive and workers lose motivation, structural unemployment (occupational immobility), possible lack of variety, employees leave regularly, non-renewable resources run out in a region, over-dependent/ reliance of certain resources and the weather, lack of competition arguably.
Specialisation necessitates an efficient means of exchanging goods and services, such as the use of money as a medium of exchange.
Previously, barter was used as goods were traded for each other. The problem was that there had to be a double coincidence of wants.
Money acts as a store of value, measure of value, standard of deferred payment and a medium of exchange. Money is durable, acceptable, portable and divisible.

4.1.4.3 The Law of Diminishing Returns and Returns to Scale

In the short run, at least one factor of production cannot change, so there is at least one fixed cost.
In the long run, all factor inputs can change, so all costs are variable.
The marginal return of a factor is the extra output derived per extra unit of the factor employed.
Average return is the output per unit of input.
Total return is the total output produced by a number of units of factors over a period of time. The amount of capital is fixed.
The law of diminishing returns only occurs in the short run. It states that as a variable factor of production is added to a fixed factor of production, eventually the marginal and then the average returns to the variable factor will begin to fall.
Returns to scale: the rate by which output changes if the scale of all factors of production is changed.
Returns to scale increase when the output increases by a greater proportion to the increase in inputs and vice versa.

4.1.4.4 Costs of Production

Fixed costs don’t vary with output (they are indirect e.g. capital/ land).
Variable costs vary with output (they are direct e.g. raw materials).
Marginal cost = change in total cost/ change in total output
Average cost = cost per unit output
Total cost = TVC + TFC
The reason the marginal costs curve is shaped as it is is because initially average costs fall when input increases, but then they rise. They always cut through the lowest point of the LRATC curve.
The LRATC curve is u-shaped due to economies and diseconomies of scale.

4.1.4.5 Economies and Diseconomies of Scale

Economies of scale are when average costs of production fall as output increases.
Internal economies of scale occur when firms become larger (RFMTMP): risk-bearing, financial, managerial, technological, marketing, and purchasing.
External economies of scale occur when an entire industry grows: firms can benefit from better transport links and roads, research and development or better education and training available to workers.
Diseconomies of scale occur when output exceed a certain point (CCC): control (monitor how productive a large workforce is), coordination (managing individual workers), communication (workers feel alienated).
The minimum efficient scale of production is the lowest output at which the firm is able to produce at the minimum achievable LRAC.
The L-shaped long run average cost curve is a development that suggests economies of scale causes average costs to fall rapidly as output first begins to increase. Then, as managerial costs rise, technical or marketing economies of scale offset these, allowing costs to continue to fall, just at a slower rate.

4.1.4.5 Marginal, Average and Total Revenue

Total revenue equals price times quantity sold.
Average revenue equals total revenue divided by quantity sold (the price).
Marginal Revenue is the additional revenue gained by the sale of one extra unit of the good or service.
The average revenue is the firm’s demand curve.
When demand is perfectly elastic, marginal revenue equals average revenue (perfectly competitive markets).
In imperfect markets, marginal revenue is always twice as steep as average revenue.
Marginal revenue is the change in total revenue divided by the change in quantity sold.
In perfectly competitive markets, marginal revenue is constant and therefore, total revenue is an upward slowing, straight line.
In imperfect markets, average revenue and marginal revenue are downward sloping due to firms being price takers. Total revenue is an upward sloping curve until the point where marginal revenue equals zero.

4.1.4.7 Profit

Profit is the difference between total revenue and total costs. It is also the reward entrepreneurs get for taking risk.
Normal profit is the minimum profit a firm must make to stay in business, which is, however, insufficient to attract new firms into the market.
Abnormal profits are any profits above normal profit.
Profit maximisation is the main objective of firms.
Profit keeps shareholders happy as it brings them dividends (shares of profits), profit can be used for investment (cheap, interest-free finance) and helps create dynamic efficiency gains, and the profit motive also incentivises lower costs and greater efficiency.

4.1.4.8 Technological Change

Invention is the creation of a new product.
Innovation is the process of improving, developing or contributing to existing products.
Technological change can affect methods of production, productivity, efficiency and firms’ costs of production.
Technological change can lead to the development of new products, the development of new markets and may destroy existing markets.
Technological change can influence the structure of markets.
If firms have monopoly power and are able to make large profits, there will be an incentive for new firms to innovate to overcome the existing barriers to entry.
Creative destruction is the process of capitalism evolving and renewing itself over time through new innovations replacing older ones.