Producers, production and productivity
Producers are not only private firms. The specification names three kinds: individuals, such as a self-employed plumber or a market trader; firms, from a corner shop to a multinational; and the government, which produces services including schools, hospitals, roads and defence.
Two words that sound alike mean different things, and questions test the difference directly.
- Production
- The total output produced — how much is made.
- Productivity
- Output per unit of input, usually output per worker per hour — how efficiently it is made.
A factory that hires twice as many workers and doubles its output has doubled production, but productivity has not changed at all — each worker still produces the same amount. Productivity only rises when the same input produces more output.
Why productivity matters is the evaluation the specification asks for. Higher productivity means lower cost per unit, so firms can charge lower prices and still make a profit, or earn a larger margin. Across a whole economy it is the main source of long-run economic growth, and the main way wages can rise without prices rising with them. It rises through better training and education, better machinery and technology, and better organisation and motivation of workers.
Costs, revenue, profit and loss
The specification asks you to calculate and explain six figures, so learning them as a set of formulas that build on each other is quicker than learning six separate facts.
Fixed costs do not change with output — rent, insurance, salaries of permanent staff, loan repayments. They are paid whether the firm produces one unit or a thousand, and even if it produces nothing at all.
Variable costs change directly with output — raw materials, packaging, and wages of staff paid by the hour or by the unit. Producing nothing means paying no variable costs.
That distinction is what makes average cost fall as output rises: fixed costs are spread over more units, so each unit carries a smaller share of them.
Worked example
A firm has fixed costs of £4,000 a month and variable costs of £6 per unit. It produces and sells 1,000 units at £14 each. Calculate total cost, average cost, total revenue, average revenue and profit.
- Variable costs in total: £6 × 1,000 = £6,000.
- Total cost = fixed + variable = £4,000 + £6,000 = £10,000.
- Average cost = total cost ÷ output = £10,000 ÷ 1,000 = £10.
- Total revenue = price × quantity = £14 × 1,000 = £14,000.
- Average revenue = total revenue ÷ output = £14,000 ÷ 1,000 = £14, which is the price, as expected.
- Profit = total revenue − total cost = £14,000 − £10,000 = £4,000.
Answer: Total cost £10,000; average cost £10 per unit; total revenue £14,000; average revenue £14 per unit; profit £4,000. The firm makes £4 of profit on each unit, because it sells at £14 and each unit costs £10 to produce once fixed costs are shared out.
Why these figures matter to producers is the evaluation, and the specification points at one link in particular: how costs and revenues affect profit and supply.
A firm supplies a good only if the price covers the cost of producing it. If costs rise and the price does not, profit per unit falls, and at some point production is no longer worthwhile — so the firm produces less, or leaves the market. That is exactly the leftward shift of the supply curve in 2.3. A rise in costs and a fall in supply are the same event described two ways.
Profit also funds the future: it is what a firm reinvests in new machinery, new products and expansion. A firm making losses cannot do any of that, and cannot continue indefinitely.
- Fixed costs
- costs that do not change with output — rent, insurance, permanent salaries, loan repayments — paid whether anything is produced or not
- Variable costs
- costs that change with the level of output, such as raw materials
- Total revenue
- price multiplied by quantity sold
Economies of scale
Economies of scale are the cost advantages a firm gains as it grows: as output rises, the average cost of producing each unit falls.
The word average is doing the work. Total cost always rises with output — making more things costs more. What falls is the cost per unit.
The reasons are worth naming, because a question asking to explain one wants a named source and an explanation, not a general statement that bigger is cheaper:
• Bulk buying — a large firm buys materials in quantity and negotiates a discount per unit • Technical — expensive machinery can be used to full capacity, so its cost is spread over far more units • Financial — large firms borrow at lower interest rates, because lenders see them as safer • Marketing — the cost of an advertising campaign is the same whether it sells one million units or two, so the cost per unit halves • Managerial — a specialist accountant or marketing manager is worth employing only at a large scale, and does the job better than a generalist
Diseconomies of scale set the limit. Beyond a certain size, average cost starts to rise again: communication becomes slower and messages get distorted, layers of management add cost without adding output, and workers feel like a small part of something impersonal and become less motivated. That is why the average cost curve turns upwards at the right-hand end.
Common mistake
Economies of scale do not mean total costs fall. Total costs rise as output rises — it is average cost per unit that falls. Saying "costs go down" without the word average loses the mark.
- Economies of scale
- the cost advantages a firm gains as it grows: as output rises, the average cost of producing each unit falls
- Diseconomies of scale
- the rise in average cost that occurs when a firm grows too large to coordinate efficiently
Before you practise
- Producers include individuals, firms and the government.
- Production is how much is made; productivity is output per unit of input.
- Higher productivity lowers cost per unit and is the main source of long-run growth.
- Total cost = fixed + variable; average cost = total cost ÷ output.
- Total revenue = price × quantity; average revenue = total revenue ÷ output, which equals price.
- Profit = total revenue − total cost; a loss is when cost exceeds revenue.
- Fixed costs are paid whatever the output; variable costs change with it.
- Rising costs reduce profit per unit and shift supply left.
- Economies of scale lower average cost: bulk buying, technical, financial, marketing and managerial.
- Diseconomies of scale — poor communication, extra management layers, lower motivation — eventually raise it again.