3.3 Revenues, Costs and Profits

Total Revenue (TR)

Price x Quantity sold

Average Revenue (AR)

Total revenue / Quantity sold

Marginal Revenue (MR)

Change in total revenue / Change in quantity sold 

Price Elasticity of Demand (PED)

%Change in Quantity Demanded / %Change in price 

The effect on total revenue when PED > 1

A fall in price causes total revenue to rise.

The effect on total revenue when PED < 1

A fall in price causes total revenue to fall.

The effect on total revenue when PED = 1

Total revenue is at its maximum so marginal revenue equals zero at this point. 

Total cost (TC)

Total fixed cost + Total variable cost 

Total fixed cost (TFC)

All costs that do not change with output.

Total variable cost (TVC)

All costs that vary directly with output.

Average total cost (ATC)

Total cost / Output 

Average fixed cost (AFC)

Total fixed cost / Output

Average variable cost (AVC)

Total variable cost / Output 

Marginal cost (MC)

Change in total cost / Change in output

The law of diminishing marginal productivity

As more variable factors (labour) are added to a fixed factor, marginal product eventually falls. 

The short-run effect on marginal cost when marginal product rises

Marginal cost falls

The short run effect on marginal cost when marginal product falls

Marginal cost rises

Economies of scale

When a firm’s average cost per unit falls as output increases. 

Diseconomies of scale

When a firm’s average cost per unit rises as output increases.

Technical economies of scale

Using larger-scale, more efficient machinery and production methods reduces cost per unit. 

Managerial economies of scale

Larger firms can employ specialist managers leading to better decisions, higher efficiency. 

Purchasing economies of scale

Bigger firms buy inputs in large quantities and negotiate lower prices per unit. 

Marketing economies of scale

Advertising and marketing costs are spread over more units, reducing cost per unit of output. 

Financial economies of scale

Large firms can borrow money at lower interest rates because lenders see them as less risky. 

Risk-bearing economies of scale

Large firms can spread risk across multiple products and markets, reducing cost of failure.

Communication problems

Harder to pass messages accurately in a large organisation means mistakes and higher costs. 

Co-ordination problems

More layers of management and departments makes planning harder and slower leading to inefficiency and higher costs.

Motivation problems

Workers may feel anonymous and less valued in large firms which means motivation drops and productivity falls so cost rises. 

Bureaucracy issues

Large firms often require more paperwork, procedures and approvals which is time wasted leading to increased costs. 

Minimum Efficient Scale (MES)

The smallest level of output at which a firm can fully exploit all economies of scale, so average cost is minimised. 

The effect of large minimum efficient scales on industries

Oligopolies and a small number of large firms dominating the market.

The effect of small minimum efficient scales on industries

Many small firms surviving and monopolistic competition occuring.

Internal Economies of Scale

Occur within the firm and are caused by the firm growing in size and the firm will reduce its own average cost. 

External Economies of Scale

Occur within the industry and are caused by industry or region growth and all firms in that industry benefit. 

Profit maximisation point

When MR = MC because at this point, producing one more unit adds the same to revenue as it does to cost.  

Normal Profit

The minimum profit needed to keep resources in their current use (AR = ATC). 

Supernormal Profit

Profit above normal profit. Attracts new firms into the industry in the long run (AR > AC).  

Loss (Subnormal Profit)

The firm is not covering all its costs (AR < AC).

Short-run shut-down point

Where AR = AVC at the MR = MC output. 

Long-run shut-down point

Where AR = AC.