Costs & Revenue (Cambridge (CIE) O Level Economics)

Revision Note

Written by: Steve Vorster

Reviewed by: Jenna Quinn

Different Types of Costs

In preparing goods/services for sale, firms incur a range of costs. These costs can be be broken into different categories

Fixed costs (FC) are costs that do not change as the level of output changes
- These have to be paid whether output is zero or 5000
  - E.g. Building rent, management salaries, insurance, bank loan repayments etc.
Variable costs (VC) are costs that vary directly with output
- These increase as output increases and vice versa
  - E.g. raw material costs, wages of workers directly involved in production
Total costs (TC) are the sum of the fixed + total variable costs

Cost Calculations

Based on the above definitions, we can calculate several different types of costs

$Total costs (TC) = total fixed costs (TFC) + total variable costs (TVC)$
$Total variable cost (TVC) = variable cost (VC) \times quantity (Q)$
$Average total cost (AC) = \frac{total cost (TC)}{quantity (Q)}$
$Average fixed cost (AFC) = \frac{Total fixed costs (TFC)}{quantity (Q)}$
$Average variable cost (AVC) = \frac{Total variable costs (TVC)}{quantity (Q)}$

Cost Calculations Using the Above Formulas Where VC Is $60

Output (Q)	TFC	TVC = $$ 60 x Q$	TC = $TFC + TVC$	AFC = $\frac{TFC}{Q}$	AVC = $\frac{TVC}{Q}$	AC = $\frac{TC}{Q}$
0	200	-	200	-	-	-
1	200	60	260	200	60	260
2	200	120	320	100	60	160
3	200	180	380	66.67	60	126.67
4	200	240	440	50	60	110
5	200	300	500	40	60	100
6	200	360	560	33.34	60	93.33
7	200	420	620	28.58	60	88.57
8	200	480	680	25	60	85

Diagrammatic Representation of Costs

Sketches Which Represent the Different Costs of a Firm

Type of Cost	Diagram	Explanation
Fixed Cost (FC)		The firm has to pay its fixed costs which do not change, irrespective if the output is 0 or 100,000 units The fixed costs for this firm are $4,000
Variable Cost (VC)		The variable costs initially rise proportionally with output, as shown in the diagram At some point the firm will benefit from a purchasing economy of scale and the rise will no longer be proportional
Total Cost (TC)		The total cost is the sum of the variable and fixed costs The total costs cannot be 0 as all firms have some level of fixed costs
Average Fixed Cost (AFC)		If the fixed costs of a firm are $1,000 and it produces 1 unit of output, then its AFC is $1,000 ($1,000/1) If the firm increases its output to 1000 units, then the AFC is $1 per unit ($1000/1,000) The more units a firm produces, the lower its AFC will be This is one reasons why large levels of output help to increase the profit per unit
Average Total Cost (AC)		As a firm grows, it is able to increases its scale of output generating efficiencies that lower its average total costs (AC) of production These efficiencies are called economies of scale As a firm continues increasing its scale of output, it will reach a point where its average total costs (AC) will start to increase The reasons for the increase in the average costs are called diseconomies of scale

Examiner Tips and Tricks

MCQ frequently tests your knowledge of these curves by presenting you with 4 unlabelled diagrams and, for example, asking you to identify which sketch demonstrates the average fixed costs of the firm.

Different Types of Revenue

Total revenue is the total value of all sales a firm incurs

$Total revenue (TR) = selling price (P) \times quantity sold (Q)$

Average revenue is the overall revenue per unit

$Average revenue (AR) = \frac{TR}{Q}$

An Example of Revenue Calculations

P ($)	Q	TR $(P \times Q)$	AR $\frac{TR}{Q}$
8	1	8	8
7	2	14	7
6	3	18	6
5	4	20	5
4	5	20	4
3	6	18	3
2	7	14	2
1	8	8	1

Average revenue information is especially useful to a firm selling multiple products (e.g. supermarkets) or a firm that sells the same item at different prices (e.g. rail tickets are usually priced differently for different types of commuters e.g. pensioners)

Last updated: 18 June 2024

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