Cambridge O Level Economics: Costs, revenue and objectives of firms (2281)

This guide teaches parts 3.7.1 to 3.7.5 (firms’ costs, revenue and objectives) of the Cambridge O Level Economics 2281 syllabus for examination in 2026, version 2. They fall under Topic 3, Microeconomic decision makers. There is no tiering. The syllabus says marginal cost and marginal revenue are outside what you need, so they never appear below. Every firm and figure below is invented and illustrative; none is real data.

Related pages: the Topic 3 overview, the revision notes, the practice questions, the course hub, the printable checklist and the free diagnostics.

What you must be able to do

Section	Outcome
3.7.1	Define TC, ATC, FC, VC, AFC and AVC
3.7.2	Calculate them; define, draw and interpret diagrams of how output changes costs
3.7.3	Define TR and AR
3.7.4	Work out TR and AR, and show how sales affect revenue
3.7.5	Discuss the objectives named: survival, social welfare, profit maximisation and growth

The assessment overview says Paper 1 questions may include calculations and that calculators may be used in the examination. Show your working anyway: a written line such as TC = FC + VC = 480 + 880 shows the examiner your method.

3.7.1 The six cost definitions

Costs of production are the money a firm spends to produce its output.

• Fixed cost (FC): a cost that does not change when output changes, such as rent, insurance or a loan repayment. It is still paid if output is zero.
• Variable cost (VC): a cost that changes directly with output, such as flour, packaging or the energy used by machines.
• Total cost (TC): the full bill for making a given output. TC = FC + VC.
• Average fixed cost (AFC): the share of fixed cost carried by each unit. AFC = FC ÷ output.
• Average variable cost (AVC): the variable cost of each unit. AVC = VC ÷ output.
• Average total cost (ATC): the cost of each unit including fixed cost. ATC = TC ÷ output, and ATC = AFC + AVC.

A cost is fixed or variable according to how it behaves, not what it is called. Wages are variable if workers are paid per item or per hour worked, but fixed if a worker has a monthly salary whatever the output. Say which you are assuming.

3.7.2 Calculating costs and reading the diagrams

Worked example 1: a bakery cost table

Corner Loaf Bakery is an invented firm. Its fixed cost is 480 a week. The variable cost at each weekly output is given.

Loaves	VC	TC	AFC	AVC	ATC
100	300	780	4.80	3.00	7.80
200	520	1,000	2.40	2.60	5.00
300	690	1,170	1.60	2.30	3.90
400	880	1,360	1.20	2.20	3.40
500	1,150	1,630	0.96	2.30	3.26
600	1,500	1,980	0.80	2.50	3.30
700	1,880	2,360	0.69	2.69	3.37
800	2,450	2,930	0.60	3.06	3.66

Working for 400 loaves:

1. TC = FC + VC = 480 + 880 = 1,360.
2. AFC = 480 ÷ 400 = 1.20.
3. AVC = 880 ÷ 400 = 2.20.
4. ATC = 1,360 ÷ 400 = 3.40.
5. Check: AFC + AVC = 1.20 + 2.20 = 3.40, which matches.

Working backwards from averages

Averages can be turned back into totals by multiplying by output. Suppose a pottery (invented) has ATC of 29 and AFC of 12 at 30 pots.

1. AVC = ATC − AFC = 29 − 12 = 17.
2. FC = AFC × output = 12 × 30 = 360.
3. TC = ATC × output = 29 × 30 = 870.
4. VC = TC − FC = 870 − 360 = 510, and 510 ÷ 30 = 17, which agrees with step 1.

The shape of the cost curves

On a diagram, output goes on the horizontal axis and cost, or cost per unit, goes on the vertical axis.

Total cost curves. FC is a horizontal line (480 in example 1). VC starts at the origin and rises. TC starts on the vertical axis at the level of FC and lies exactly 480 above VC at every output, so TC and VC are parallel.

Average cost curves. In sketch form, with output on the horizontal axis and cost per unit on the vertical axis:

Curve	Start and direction
AFC	Starts high, slopes down, flattens towards the axis
AVC	Slopes down, bottoms out, then curves up (a U)
ATC	Sits above AVC, same U shape, bottoms out further right

• AFC falls all the way. The same fixed cost is shared among more units: 4.80 each at 100 loaves, 0.60 each at 800. The curve flattens out towards the horizontal axis without reaching it, since FC is above zero.
• AVC is U-shaped. In the table it falls to 2.20 at 400 loaves and then rises.
• ATC is also U-shaped and lies above AVC. Its lowest point (3.26 at 500 loaves) is to the right of the lowest AVC point (400 loaves).
• The vertical gap between ATC and AVC is AFC. The gap narrows as output rises, so the two curves move closer together.

Why is ATC lowest further right than AVC? Just past the lowest AVC point, the fall in AFC per extra loaf is bigger than the rise in AVC, so ATC carries on down for a while. In the table, from 400 to 500 loaves AFC drops 0.24 but AVC rises only 0.10.

Why might AVC fall and then rise? At low output a small bakery’s oven and staff are under-used, so extra loaves are cheap to make. At high output the same oven and kitchen become crowded, workers get in each other’s way, and extra loaves cost more. This is a plausible explanation, not a law: tell the story of the firm in the question.

Examiner insight: when you draw a diagram, label both axes and every curve. A U-shaped curve with no label gives the reader nothing to credit.

3.7.3 Revenue

• Total revenue (TR): all the money coming in from sales. TR = price × quantity sold.
• Average revenue (AR): what the firm earns on each unit it sells. AR = TR ÷ quantity sold.

If every unit is sold at one price, AR equals that price. That is why AR is the same thing as the price line on a diagram.

3.7.4 Working out revenue and the effect of sales

Worked example 2: sales at a fixed price

Corner Loaf sells every loaf at 4.00. TR is 4.00 × quantity, and profit is TR − TC. Using example 1:

Loaves	TR	TC	Profit
200	800	1,000	−200
300	1,200	1,170	30
500	2,000	1,630	370
700	2,800	2,360	440
800	3,200	2,930	270

At 200 loaves the firm takes in 800 but spends 1,000, a loss of 200. At 300 loaves TR just exceeds TC, so the firm starts to make a profit. At 700 loaves AR is 4.00 and ATC is 3.37, so profit per loaf is about 0.63 and 700 × 0.63 is about 440. The best profit in the table is at 700 loaves, because at 800 loaves the cost of the extra output (570) is higher than the extra revenue (400).

With a fixed price, more sales always mean more revenue, but not always more profit.

Worked example 3: changing the price

A print shop (invented) finds that sales depend on price.

Price per poster	Posters sold	TR	Change in TR
10	50	500
9	58	522	+22
8	70	560	+38
7	78	546	−14
6	80	480	−66

Step by step, TR = 9 × 58 = 522 and so on. From 10 to 9, price falls 10% but sales rise 16%, so TR rises. From 8 to 7, price falls 12.5% but sales rise only 11.4%, so TR falls. A price cut raises TR only when the percentage rise in sales is bigger than the percentage fall in price. You do not need marginal revenue for this.

The same logic works in reverse. A price rise raises TR only when sales fall by a smaller percentage than the price rose.

Worked example 4: when AR is not the list price

A stall sells 100 scarves. It sells 60 at 12 and the other 40 at a discounted 9.

1. TR = 60 × 12 + 40 × 9 = 720 + 360 = 1,080.
2. AR = 1,080 ÷ 100 = 10.80, which is below the 12 list price.

Selling all 100 at 12 would give 1,200, so discounts cost the stall 120.

3.7.5 Objectives of firms

A firm’s objective is the goal that guides its decisions. The syllabus lists four.

Survival. The firm aims to stay in business. This matters most for new firms and in a recession. A survival price must at least cover costs. Example: in the Corner Loaf table, a price of 3.30 at 600 loaves gives TR of 1,980, equal to TC, so the firm breaks even. A firm might even trade for a short time at a loss if TR covers VC. At a price of 3.00 for 400 loaves, TR is 1,200 and VC is 880, so there is 320 towards fixed costs, but a loss of 160 overall (1,200 − 1,360). It cannot do this for ever.

Social welfare. The firm aims to benefit society, not to make the most profit. Examples are a cooperative bakery that sells bread at cost, or a charity clinic. Such firms may still need revenue to cover costs, or they depend on donations or subsidies.

Profit maximisation. The firm aims for the biggest gap between TR and TC. In example 2 this is 700 loaves, with profit of 440.

Growth. The firm aims to become bigger, measured by sales, output, market share or number of outlets. Growth often means accepting lower profit now. If Corner Loaf cut its price to 3.60 to sell 800 loaves, TR would be 2,880 and profit would be 2,880 − 2,930 = −50. Sales rise 14.3% on 700 loaves, but profit swings from 440 to a loss of 50, a worsening of 490.

Evaluating objectives

Objectives are not mutually exclusive and they change. A new firm may choose survival, then growth, and later profit. Chain of reasoning: lower price, more sales, bigger market share, possibly lower costs per unit later, but less profit now and a risk that rivals copy the price cut. A good evaluation says what the objective depends on: the firm’s age, its owners, competition and whether the owners have other sources of money.

Examiner insight: a question that gives you figures expects numbers in your answer. Quote them, then add the economic reason.

Common errors

• Dividing by the wrong output, or forgetting to divide at all, so TC is reported as ATC.
• Saying AFC is fixed. Fixed cost is fixed; average fixed cost falls as output rises.
• Drawing TC starting at the origin. It starts at the level of FC.
• Calling AR the same as TR.
• Assuming the highest TR is the highest profit.
• Naming an objective without linking it to evidence in the question.

Next steps

Condense this with the revision notes, then test yourself with the practice questions.

Official syllabus

Cambridge International, Cambridge O Level Economics 2281 syllabus for examination in 2026, version 2, section 3.7. Cambridge University Press & Assessment.