Key AS Micro Terms: Costs and Profits

This blog provides revision definitions of concepts related to production, costs and profits and also links to recent revision blogs and revision presentations for students taking their Unit 1 Economics papers. Click to the bottom of the blog for the related revision posts.

Average cost: Average or unit cost (AC) is the total cost divided by the number of units of the commodity produced.

Average fixed cost: Fixed costs are costs of production which are constant whatever the level of output. Average fixed costs are total fixed costs divided by the number of units of output, that is, fixed cost per unit of output

Capacity utilisation: The extent to which a business is making full use of existing factor resources

Capital intensive production: A production technique which uses a high proportion of capital to labour

Costs: Costs are those expenses faced by a business when producing a good or service for a market. Every business faces costs - these must be recouped if a business is to make a profit from its activities. In the short run a firm will have fixed and variable costs of production

Diminishing returns: As more of a variable factor (e.g. labour) is added to a fixed factor (e.g. capital) a firm will reach a point where it has a disproportionate quantity of labour to capital and so the marginal product of labour will fall, thus raising marginal costs

Division of labour: The specialization of labour in specific tasks and roles, intended to increase the productivity of labour

Economy of scale: Reductions in the long run average cost of production arising from an increase in the scale of production

Economy of scope: Economies of scope occur where it is cheaper to produce a range of products

External cost: External costs are those costs faced by a third party for which no appropriate compensation is forthcoming

Financial economy of scale: Small firms often have to pay higher interest rates on loans since they are perceived by financial organizations to carry a higher level of risk. Firms therefore have to pay a risk premium on their loans. The smaller firm may find it more difficult to raise money through selling new shares than a larger firm

Fixed cost: These costs relate to the fixed factors of production and do not vary directly with the level of output. Examples of fixed costs include: rent and business rates, the depreciation in the value of capital equipment (plant and machinery) due to age and marketing and advertising costs

Inputs: Labour, capital and other resources used in the production of goods and services

Long run: A period of time in which all inputs may be varied but the basic technology of production is unchanged.

Marginal cost: Marginal cost is defined as the change in total costs resulting from increasing output by one unit. Marginal costs relate to variable costs only. Changes in fixed costs in the short run affect total costs, but not marginal costs

Marginal revenue: The increase in revenue resulting from an additional unit of output

Private benefit: The rewards to individuals, firms or consumers from consuming or producing goods and services. Also known as internal benefits

Private cost: The costs of an economic activity to individuals and firms. Also known as internal costs

Productivity: A measure of efficiency, expressed as output per unit of input, for example output per person employed

Profit: Profits are made when total revenue exceeds total cost. Total profit = total revenue - total cost. Profit per unit supplied = price = average total cost. The standard assumption is that private sector businesses seek to make the highest profit possible from operating in a market but this has been questioned by many studies of how real world businesses operate

Social cost: The cost of production or consumption of a product for society as a whole. Social cost = private cost + external cost

Subsidy: Subsidies represent payments by the government to suppliers that have the effect of reducing their costs and encouraging them to increase output. The effect of a subsidy is to increase supply and therefore reduce the market equilibrium price

Supply: Supply is the quantity of a good or service that a producer is willing and able to supply onto the market at a given price in a given time period. The basic law of supply is that as the market price of a commodity rises, so producers expand their supply onto the market.

Variable cost: Variable costs vary directly with output. I.e. as production rises, a firm will face higher total variable costs because it needs to purchase extra resources to achieve an expansion of supply. Common examples of variable costs for a business include the costs of raw materials, labour costs and consumables.