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O LevelEconomicsCambridge (CIE)Revision Notes3. Microeconomic Decision Makers3.7 Firms’ Costs, Revenue & ObjectivesCosts & Revenue

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

Revision Note

Steve Vorster

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

  1. 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.

  2. 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

  3. 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

  1. Total space costs space left parenthesis TC right parenthesis space equals space total space fixed space costs space left parenthesis TFC right parenthesis space plus space total space variable space costs space left parenthesis TVC right parenthesis

  2. Total space variable space cost space left parenthesis TVC right parenthesis space equals space variable space cost space left parenthesis VC right parenthesis space cross times space quantity space left parenthesis straight Q right parenthesis

  3. Average space total space cost space left parenthesis AC right parenthesis space equals space fraction numerator total space cost space left parenthesis TC right parenthesis over denominator quantity space left parenthesis straight Q right parenthesis end fraction

  4. Average space fixed space cost space left parenthesis AFC right parenthesis space equals space fraction numerator Total space fixed space costs space left parenthesis TFC right parenthesis over denominator quantity space left parenthesis straight Q right parenthesis end fraction

  5. Average space variable space cost space left parenthesis AVC right parenthesis space equals space fraction numerator Total space variable space costs space left parenthesis TVC right parenthesis over denominator quantity space left parenthesis straight Q right parenthesis end fraction

     
    Cost Calculations Using the Above Formulas Where VC Is $60

Output (Q)

TFC

TVC = $ 60 space straight x space straight Q

TC = TFC plus TVC

AFC = TFC over straight Q

AVC = begin mathsize 11px style TVC over straight Q end style

AC = TC over straight 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)

3-7-1-fixed-costs

  • 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)

3-7-2-variable-costs

  • 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)

_ZxiGabU_3-7-2-total-costs

  • 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)

3-7-2-average-fixed-costs

  • 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)

3-7-2-average-total-costs

  • 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 space revenue space left parenthesis TR right parenthesis space equals space selling space price space left parenthesis straight P right parenthesis space cross times space quantity space sold left parenthesis straight Q right parenthesis

  • Average revenue is the overall revenue per unit

Average space revenue space left parenthesis AR right parenthesis space equals space TR over straight Q
  

An Example of Revenue Calculations

P ($)

Q

TR begin mathsize 14px style left parenthesis straight P cross times straight Q right parenthesis end style

AR space TR over straight 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)

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    Author
    Reviewer
    Steve Vorster

    Author: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

    Jenna Quinn

    Author: Jenna Quinn

    Expertise: Head of New Subjects

    Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.