Cambridge International AS and A Level Economics: Long-run costs, economies of scale, revenue, profit (9708)

This guide covers syllabus statements 7.5.3 to 7.5.10 of the Cambridge International AS & A Level Economics syllabus for examination in 2026, 2027 and 2028. They sit in topic 7, which is A Level content only and is not examined at AS. Every firm and figure below is invented and none is a real statistic. Money is in currency units (cu).

Statements 7.5.1 and 7.5.2 (short-run production and costs) are taught elsewhere. Use the Cambridge A Level Economics hub for the full map and the printable checklist to tick off outcomes. Then try the revision notes and the practice questions. To see where you stand, take a free 10-minute diagnostic. The price system study guide covers the wider topic.

What this guide covers

Statement	What you must be able to do
7.5.3	Explain the long-run production function: no fixed factors, returns to scale
7.5.4	Explain the shape of the long-run average cost curve and minimum efficient scale
7.5.5	Link economies of scale to decreasing average costs
7.5.6	Distinguish internal and external economies of scale
7.5.7	Distinguish internal and external diseconomies of scale
7.5.8	Define and calculate total, average and marginal revenue
7.5.9	Define normal, subnormal and supernormal profit
7.5.10	Calculate supernormal and subnormal profit

The long run and returns to scale (7.5.3)

The long run is the period in which a firm can change every factor of production. Nothing is fixed, so production is about the size, or scale, of the whole operation.

Returns to scale describe what happens to output when all inputs are increased in the same proportion.

• Increasing returns to scale: output rises by a larger percentage than inputs.
• Constant returns to scale: output rises by the same percentage as inputs.
• Decreasing returns to scale: output rises by a smaller percentage than inputs.

Do not confuse these with diminishing returns, which applies when at least one factor stays fixed. Returns to scale change every factor at once.

Worked example 1. A furniture workshop (illustrative) adds identical bundles of labour, machines and floor space. Each bundle costs 1,500 cu in the long run.

Bundles	Output	% change in inputs	% change in output	Verdict
1	100
2	230	+100.0%	+130.0%	Increasing
3	345	+50.0%	+50.0%	Constant
4	414	+33.3%	+20.0%	Decreasing

Working for 2 to 3 bundles: inputs rise by (3 − 2)/2 × 100 = 50% and output by (345 − 230)/230 × 100 = 50%, so returns are constant.

Dividing long-run total cost (1,500 × bundles) by output: 1,500/100 = 15.00; 3,000/230 = 13.04; 4,500/345 = 13.04; 6,000/414 = 14.49. Average cost falls, stays flat, then rises. With constant input prices, increasing returns lower average cost, constant returns leave it unchanged and decreasing returns raise it.

The long-run average cost curve and minimum efficient scale (7.5.4)

The long-run average cost (LRAC) curve shows the lowest average cost of producing each level of output when the firm can choose any scale. It is often drawn as a U-shape. Each short-run average cost curve belongs to one scale of plant. The LRAC is tangent to each of them at the output where that scale is the cheapest way to produce, like an envelope.

LRAC (cu)
 9.0 |*
 7.5 |   *
 6.6 |       *
 6.0 |           * - - * - - *      (flat section: MES at 40)
 6.6 |                          *
     +------------------------------ Output
        10  20  30  40  50  60  70

It falls because of economies of scale and may rise because of diseconomies. If neither dominates over a wide range of output, the bottom is flat. Some industries show a falling section and then a flat one (an L-shape), because diseconomies never appear.

Minimum efficient scale (MES) is the lowest output at which LRAC is at its minimum, so all available economies of scale have been used.

Worked example 2. A bottling firm (illustrative) has these long-run costs, with output in thousands of units.

Output	LRAC (cu per unit)	LRTC (thousand cu)
10	9.00	90
20	7.50	150
30	6.60	198
40	6.00	240
50	6.00	300
60	6.00	360
70	6.60	462

• MES is 40 thousand units, because 6.00 is the minimum average cost and 40 is the first output to reach it.
• Average cost falls by (6.00 − 9.00)/9.00 × 100 = −33.3% between 10 and 40 thousand units.
• Beyond 60 thousand units average cost rises by (6.60 − 6.00)/6.00 × 100 = 10.0%.
• Total cost still rises throughout (90 to 462), so falling average cost is not falling total cost.

MES compares firm size with market size. If market demand at the going price is 200 thousand units, at most 200/40 = 5 firms can each reach MES. A much larger MES would leave room for only one or two.

Economies of scale and falling average cost (7.5.5)

Economies of scale exist when long-run average cost falls as output rises. They are the cost-side explanation of the downward-sloping part of the LRAC curve. Increasing returns can cause them, but so can cheaper inputs, such as a bulk discount.

An internal economy of scale is a fall in LRAC that comes from the growth of the firm itself. The firm moves down along its own LRAC curve. An external economy comes from the growth of the industry and lowers the costs of every firm in it. The whole LRAC curve of each firm shifts down. Keep these apart: a movement along the curve versus a shift of the curve.

Internal and external economies of scale (7.5.6)

Internal economy	How it lowers average cost
Technical	Large machines cannot be bought in small sizes (indivisibilities), and bigger output allows specialised equipment
Purchasing	Bulk orders earn lower prices per unit from suppliers
Managerial	Specialist managers can be afforded
Financial	Large firms borrow at lower interest rates
Marketing	A fixed advertising or distribution cost is spread across more units
Risk-bearing	Several products or markets spread risk

Worked example 3. A firm pays 48,000 cu for a promotional campaign.

• At 12,000 units: 48,000/12,000 = 4.00 cu per unit.
• At 40,000 units: 48,000/40,000 = 1.20 cu per unit.
• Saving = 4.00 − 1.20 = 2.80 cu per unit, a marketing economy.

A purchasing example: a supplier charges 2.50 cu per kg normally and 2.20 cu above 5,000 kg. Buying 6,000 kg saves 0.30 cu per kg, which is 12% lower and 1,800 cu in total.

External economies include a pool of skilled labour, specialist suppliers, training colleges and shared transport links near a concentrated industry.

Worked example 4. Suppose an industry cluster cuts every firm’s costs by 8%. The bottling firm’s LRAC at 40 thousand units moves from 6.00 to 6.00 × 0.92 = 5.52 cu, and at 10 thousand units from 9.00 to 8.28 cu. Every point moves down by 8%, so the curve shifts, and MES stays at 40 thousand.

Internal and external diseconomies of scale (7.5.7)

Diseconomies of scale exist when long-run average cost rises as output rises.

Type	Examples
Internal	Long chains of command, slow communication, weak coordination, lower worker motivation, duplicated tasks
External	Congestion, higher land rents, wages bid up as firms compete for labour, strained shared infrastructure

Worked example 5. In the bottling firm, LRAC rises 10% between 60 and 70 thousand units (6.00 to 6.60 cu). Now suppose congestion pushes up the local wage by 6% and labour is half of costs. Costs rise by 0.5 × 6% = 3%, so a point on the curve at 6.00 cu moves to 6.00 × 1.03 = 6.18 cu. This affects the whole industry, so the LRAC curve shifts up, unlike the internal case.

Revenue: total, average and marginal (7.5.8)

• Total revenue (TR) = price × quantity sold.
• Average revenue (AR) = TR/quantity. This always equals the price, so plotting AR against output traces out the firm’s demand curve.
• Marginal revenue (MR) = the change in TR from selling one more unit.

A firm facing a downward-sloping demand curve must cut its price on every unit to sell more, so MR is below AR.

Worked example 6. Demand for a firm’s product is P = 22 − 2Q.

Q	P = AR	TR	MR
1	20	20	20
2	18	36	16
3	16	48	12
4	14	56	8
5	12	60	4
6	10	60	0
7	8	56	−4

For the third unit, MR = 48 − 36 = 12. TR rises while MR is positive, peaks when MR is zero, and falls when MR is negative. For a straight-line demand curve, MR has the same vertical intercept and twice the slope: here TR = 22Q − 2Q², so MR = 22 − 4Q. At Q = 2.5, the formula gives 22 − 10 = 12, matching the third unit.

MR is positive where demand is price elastic and negative where it is inelastic. At Q = 3 and P = 16, the elasticity is −0.5 × 16/3 = −2.67 (elastic) and MR is positive. At Q = 6 and P = 10, it is −0.5 × 10/6 = −0.83 (inelastic) and MR is negative. Unit elasticity occurs where MR = 0.

A price taker sells at the market price however much it supplies. At 8 cu, TR for 1 to 5 units is 8, 16, 24, 32 and 40, so MR = AR = 8 and its demand curve is horizontal.

Normal, subnormal and supernormal profit (7.5.9 and 7.5.10)

Economic costs include the opportunity cost of the entrepreneur’s own time and capital. The minimum reward needed to keep the entrepreneur in the industry is normal profit, and it counts as a cost.

• Normal profit: TR = TC (including normal profit), so AR = ATC.
• Supernormal profit: TR > TC, so AR > ATC. It is profit above normal profit.
• Subnormal profit: TR < TC, so AR < ATC. The reward is below the minimum needed, even if the accounts show a positive figure.

Calculation: Profit per unit = AR − ATC. Total supernormal or subnormal profit = (AR − ATC) × quantity = TR − TC. A negative answer means subnormal profit.

Worked example 7. A print shop (illustrative) sells 2,000 jobs for 48,000 cu. Explicit costs are 36,000 cu, and the owner could earn 9,000 cu elsewhere (normal profit).

• Accounting profit = 48,000 − 36,000 = 12,000 cu.
• Supernormal profit = 12,000 − 9,000 = 3,000 cu.
• Check per unit: AR = 24.00 and ATC = (36,000 + 9,000)/2,000 = 22.50, so (24.00 − 22.50) × 2,000 = 3,000 cu.

Next year revenue falls to 42,000 cu. Accounting profit is 6,000 cu, but that is 3,000 cu below normal profit, so subnormal profit is −3,000 cu. Check: AR = 21.00, ATC = 22.50, so (21.00 − 22.50) × 2,000 = −3,000.

Another firm sells 2,500 units at AR 9.00 with ATC 10.40: TR = 22,500, TC = 26,000, so subnormal profit is −3,500 cu.

Evaluating the analysis

• Lower average cost need not reach consumers. A firm may keep it as supernormal profit unless competition forces the price down.
• Gains depend on scale relative to MES and the market. A firm below MES has cost to gain; one far past it risks diseconomies.
• External economies are outside any one firm’s control, so small firms in a cluster can match large rivals’ costs.

Common errors

• Drawing internal economies as a shift of the curve, when they are a movement along it.
• Calculating MR as TR divided by quantity, which is AR.
• Calling any positive accounting profit supernormal without deducting normal profit.

Official syllabus

Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment: statements 7.5.3 to 7.5.10.