Cambridge International AS and A Level Economics: Short-run production and costs (9708)

This guide covers sections 7.5.1 and 7.5.2 of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topics 1 to 6 of the syllabus are AS Level content and topics 7 to 11 are A Level content, so this unit is A Level only and is not examined at AS. Papers 3 and 4 are based on the A Level content, with AS knowledge assumed. Every firm, market and figure below is invented and illustrative, and money is in currency units (cu).

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What this unit covers

Section	What you must be able to do
7.5.1	Distinguish fixed and variable factors of production
7.5.1	Define and calculate total, average and marginal product
7.5.1	Explain the law of diminishing returns (law of variable proportions)
7.5.2	Define and calculate fixed costs (FC) and variable costs (VC)
7.5.2	Define and calculate TC, AC, MC, ATC, TFC, AFC, TVC and AVC
7.5.2	Explain the shapes of the short-run average cost and marginal cost curves

Long-run production, economies of scale, revenue and profit are separate parts of section 7.5. They are not taught here.

7.5.1 The short-run production function

A production function links inputs to the maximum output they can produce. In the short run, at least one factor of production is fixed. The firm cannot change it however much output it wants. In the long run no factor is fixed.

• A fixed factor does not change with output in the short run. Examples are a factory building, an oven or a rented machine.
• A variable factor can be changed quickly to alter output. Examples are hours of labour, raw materials and electricity used in production.

The short run is not a set number of months. It depends on the firm. A street-food stall can add a second grill in a week, while a power station may need years.

Total, average and marginal product

• Total product (TP) is the total output produced with a given quantity of the variable factor.
• Average product (AP) is output per unit of the variable factor: AP = TP / quantity of the variable factor.
• Marginal product (MP) is the extra output from employing one more unit of the variable factor: MP = change in TP / change in the variable factor.

Worked example 1: a small bakery

Country A has a bakery with one oven (fixed). Labour is the variable factor. The figures are illustrative.

Workers	TP (loaves)	AP	MP
0	0	–	–
1	20	20.0	20
2	50	25.0	30
3	90	30.0	40
4	124	31.0	34
5	150	30.0	26
6	165	27.5	15
7	170	24.3	5

Working for the fourth worker: MP = 124 - 90 = 34 loaves, and AP = 124 / 4 = 31.0 loaves per worker.

What the table shows:

1. MP rises up to the third worker (20, 30, 40). Workers share tasks and specialise, so each adds more than the last.
2. From the fourth worker MP falls (34, 26, 15, 5). This is where diminishing returns begins.
3. TP keeps rising while MP is positive. TP would fall only if MP became negative.
4. AP rises while MP is above AP and falls once MP is below AP. At the fourth worker MP (34) is above the previous AP (30), so AP rises to 31. At the fifth, MP (26) is below AP (31), so AP falls to 30. The MP curve therefore cuts the AP curve at the maximum of AP.

The law of diminishing returns

The law of diminishing returns (law of variable proportions) states that, as more of a variable factor is added to a given quantity of fixed factors, the marginal product of the variable factor will eventually fall.

In the bakery, the oven does not change. By the fourth worker there is not enough oven space and equipment for everyone to work at full speed. The extra output from each new worker shrinks.

Conditions that matter:

• At least one factor is fixed, so the law applies only in the short run.
• Other things stay equal, including technology. A better oven shifts the whole production function.
• Units of the variable factor are of equal quality.
• Diminishing returns means marginal product falls. It does not mean total product falls. Total product falls only when MP is negative.

7.5.2 The short-run cost function

Fixed and variable costs

• Fixed costs (FC) do not change with output in the short run. Rent on the bakery and loan repayments on the oven are examples. They are paid even at zero output.
• Variable costs (VC) change as output changes. Flour, energy used in baking and the wages of extra workers are examples.

Do not describe a wage bill as fixed just because a worker has a contract. If the firm can change the number of workers as output changes, that cost is variable.

The cost measures

Measure	Definition	Calculation
TFC	Total fixed costs	Given, or AFC x Q
TVC	Total variable costs	Given, or AVC x Q
TC	Total cost	TFC + TVC
AFC	Fixed cost per unit	TFC / Q
AVC	Variable cost per unit	TVC / Q
ATC (AC)	Total cost per unit	TC / Q, or AFC + AVC
MC	Extra cost of one more unit	Change in TC / change in Q

Q means quantity of output. The syllabus uses AC and ATC for average total cost, so treat them as the same measure.

Worked example 2: the bakery’s costs

Suppose the oven costs 60 cu per day (fixed) and each worker is paid 40 cu per day. Using the output from worked example 1:

Workers	Q	TVC	TC	AFC	AVC	ATC	MC
1	20	40	100	3.00	2.00	5.00	2.00
2	50	80	140	1.20	1.60	2.80	1.33
3	90	120	180	0.67	1.33	2.00	1.00
4	124	160	220	0.48	1.29	1.77	1.18
5	150	200	260	0.40	1.33	1.73	1.54
6	165	240	300	0.36	1.45	1.82	2.67
7	170	280	340	0.35	1.65	2.00	8.00

Working for five workers: TVC = 5 x 40 = 200. TC = 60 + 200 = 260. AFC = 60 / 150 = 0.40. AVC = 200 / 150 = 1.33. ATC = 260 / 150 = 1.73, which also equals 0.40 + 1.33 (rounded). MC for the move from 124 to 150 loaves = (260 - 220) / (150 - 124) = 40 / 26 = 1.54.

The table shows a link between the two halves of this unit. When labour is the only variable factor and the wage is constant, MC = wage / MP and AVC = wage / AP. At the fourth worker, MC = 40 / 34 = 1.18. A high MP means a low MC, and a falling MP means a rising MC.

Each MC figure is the average cost per loaf over a block of output. On a diagram it is plotted at the middle of that block.

Explaining the shapes of the curves

Marginal cost: falls, then rises

MC is the mirror image of MP. While extra workers add more and more output (increasing marginal returns), each extra loaf costs less. In the bakery MC falls to 1.00 at the third worker. Once diminishing returns sets in, each extra worker adds less output for the same wage, so MC rises. This gives the typical swoosh-shaped MC curve, and its rising part is the result of diminishing returns.

AFC: falls all the way

TFC is constant, so AFC = TFC / Q falls as Q rises. The same fixed bill is spread over more units. AFC gets closer to the horizontal axis but never touches it. In the bakery, AFC falls from 3.00 to 0.35.

AVC: U-shaped

AVC falls at first because of increasing returns, then rises because of diminishing returns. AVC is lowest where AP is highest (the fourth worker, 124 loaves, AVC 1.29).

ATC: U-shaped, with its minimum to the right of AVC’s

ATC = AFC + AVC. The gap between ATC and AVC is AFC, which shrinks as output grows. When AVC begins to rise, AFC is still falling by more, so ATC carries on falling for a while. ATC reaches its minimum later than AVC. In the bakery, AVC is lowest at 124 loaves and ATC is lowest at 150 loaves.

Why MC cuts AVC and ATC at their minimum points

An average moves towards the marginal figure. Take four items averaging 12. A fifth item of 20 lifts the average to (48 + 20) / 5 = 13.6. A fifth item of 8 lowers it to (48 + 8) / 5 = 11.2. So:

Output range	MC compared with AVC	AVC
Up to 124	MC below	Falling
Around 124	MC equals AVC	Minimum
Beyond 124	MC above	Rising

The same rule applies to ATC, with its minimum at 150 loaves. The bakery’s MC for 124 to 150 loaves (1.54) is below ATC (1.77 at 124), so ATC is still falling. For 150 to 165 loaves MC (2.67) is above ATC (1.73), so ATC rises. The MC curve therefore cuts both AVC and ATC from below at their lowest points.

What shifts the curves

• A rise in fixed costs, such as rent, raises TFC, AFC, TC and ATC. It does not change TVC, AVC or MC, because MC depends only on the extra cost of extra output.
• A rise in a variable cost, such as the wage, raises TVC, AVC, ATC and MC.
• Better technology that raises MP lowers MC and AVC.

Evaluation points for longer answers

• The textbook MC = wage / MP assumes a constant wage. If overtime pay applies at high output, MC rises even faster.
• Real firms may find it hard to separate fixed and variable costs. A salaried manager’s pay is fixed at first but may become variable over time.
• Diminishing returns begins when MP starts to fall, which is before MC meets AVC. Costs per unit can keep falling for some time after returns start to diminish.

Common errors

• Writing that diminishing returns means output falls. Output rises more slowly; it falls only if MP is negative.
• Using diminishing returns to describe a firm that doubles all its inputs. That is a long-run question and belongs to another part of the syllabus.
• Treating MC as TC divided by Q. That is ATC.
• Saying AFC is U-shaped. It falls throughout.
• Saying MC cuts ATC at the minimum of MC. It cuts at the minimum of ATC.
• Drawing a rise in rent as a shift in MC.

Exam practice

Practise turning a production table into a cost table, as in worked example 2. Then write a chain: MP falls, so MC rises, so AVC and then ATC turn up. The practice questions include extended items of this kind.

Official syllabus

Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment, sections 7.5.1 and 7.5.2.