OCR A Level Economics: Economies of scale, revenue and profit (H460) – Revision Notes

These notes condense the full study guide for the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021. They cover long run costs, revenue and profit in Component 1, Microeconomics. The specification labels no content as AS or Extension. All figures are invented and illustrative.

Use them with the practice questions, the OCR Economics hub, the printable checklist and the free diagnostics. Elasticity is revised in the elasticity guide.

Key definitions

Term	Meaning
SRAC	Average cost with at least one fixed factor
LRAC	Cheapest cost per unit at each output once every factor can change; the envelope of the SRAC curves
Internal economy of scale	Fall in LRAC as the firm itself grows; movement along LRAC
External economy of scale	Fall in every firm’s costs as the industry grows; LRAC shifts down
Diseconomies	Rise in LRAC, internal (movement along) or external (shift up)
MES	Smallest output at which LRAC reaches its floor
TR, AR, MR	Money from all sales; revenue per unit (= price); extra TR from one more unit
Accounting profit	TR minus explicit costs
Economic profit	TR minus explicit and implicit costs
Normal profit	Least return that keeps resources in their present use; counted within TC
Supernormal profit	Profit above normal profit: TR > TC
Loss	TR < TC

Formulas

Quantity	Formula
Profit	TR − TC
Profit per unit	AR − AC
Total supernormal profit or loss	(AR − AC) × output
AR	TR/Q, which equals P
MR	Change in TR/change in Q
Straight-line demand P = a − bQ	MR = a − 2bQ
Point PED	(change in Q/change in P) × (P/Q)
MR and PED	MR = P(1 + 1/PED)
Percentage change	(new − old)/old × 100
Firms at MES	Market size/MES

SRAC, LRAC and scale

• Each plant size has its own SRAC. The LRAC touches the lowest point of each choice and never lies above any SRAC.
• Falling LRAC means economies of scale, flat means constant returns and rising LRAC means diseconomies.
• Internal economies: technical, purchasing, managerial, financial, marketing, risk-bearing.
• Internal diseconomies: control and coordination, communication, motivation.
• External economies: skilled labour pool, specialist suppliers, shared infrastructure.
• External diseconomies: congestion, higher rents, wages bid up.

Method for an economies-of-scale calculation.

1. Find total cost at each output.
2. Divide by output to get AC.
3. Compare percentage changes: AC falls if cost rises by less than output.

Reminder. A firm raises output from 10,000 to 20,000 units and LRTC goes from £90,000 to £138,000. AC moves from £9.00 to £6.90, a fall of 23.3%. Output rose 100% but cost only 53.3%.

MES

• MES is the lowest output reaching minimum LRAC.
• Compare it with market size. A market of 90,000 units and an MES of 15,000 gives 90,000/15,000 = 6 firms.
• A small MES relative to the market means many firms and low barriers. A large MES means few firms, perhaps one, and high barriers.
• A firm below MES has higher costs. If AC is £11.00 against £8.80 at MES, it is (11.00 − 8.80)/8.80 × 100 = 25% above the minimum.

Evaluating scale

Evaluate the causes by asking how large each effect is, how soon it appears, and what limits it. Evaluate significance for each agent.

Agent	Possible effect
Firm	Lower costs, price flexibility, barrier to entry, risk of diseconomies
Consumers	Lower prices if the saving is passed on
Workers	Jobs from growth, or redundancies after mergers
Government	Competition concerns where scale limits rivals

Useful evaluation points:

• Economies may take years to appear, while the costs of expansion arrive immediately.
• Diseconomies can be postponed by delegation, divisions and better information systems.
• The more concentrated the market, the less likely it is that the saving reaches consumers.
• External economies help every firm in the area, so they are less likely to become a source of market power.

Conclude with a judgement tied to the case: for example, a large MES makes the benefits more significant but also makes market power more likely.

Revenue and elasticity

• On a falling demand curve, AR is the demand curve and MR lies below it.
• For P = a − bQ, MR has the same intercept and twice the slope.
• Elastic demand (PED beyond −1): MR positive, a price fall raises TR.
• Unit elastic (PED = −1): MR = 0, TR at its maximum.
• Inelastic (PED between 0 and −1): MR negative, a price fall lowers TR.

Reminder. Demand P = 50 − 2Q. At 10 units, P = 30 and TR = 300. MR = 50 − 40 = 10. PED = −(1/2) × 30/10 = −1.5. Check: 30 × (1 − 1/1.5) = 10. TR peaks where MR = 0, at 12.5 units.

Profit

• Accounting profit exceeds economic profit by the implicit costs.
• Zero economic profit still means the owner is earning normal profit.
• On an AR and AC diagram, profit is the rectangle between AR and AC at the chosen output.
• A firm can be loss-making and still produce in the short run if AR covers AVC.

Method for MC = MR.

1. Find MR from the demand curve and MC from the cost function.
2. Set MR = MC and solve for output.
3. Read price from AR at that output.
4. Compute TR, TC and profit (or loss), and check against the neighbouring outputs.

Reminder. A firm sells 120 units at AR £25 with AC £22.50: TR is £3,000, TC £2,700, so supernormal profit is £300.

Worked reminders

Price change and TR. With P = 50 − 2Q, cutting price from 30 to 27 raises quantity from 10 to 11.5. That is +15% for a 10% price fall, so demand is elastic. TR rises from 300 to 310.5.

Profit maximised. With TC = 20 + 14Q + Q², MC = 14 + 2Q. Setting MR = MC: 50 − 4Q = 14 + 2Q, so Q = 6.

Output	Price	TR	TC	Profit	MR	MC
5	40	200	115	85	32	23
6	38	228	140	88	28	25
7	36	252	167	85	24	27

The sixth unit has MR 28 above MC 25, so it adds 3 to profit. The seventh has MR 24 below MC 27, so it lowers profit by 3. Maximum profit is £88 at price £38.

Loss minimised. If demand weakens to P = 26 − 2Q, MR = 26 − 4Q. Setting 26 − 4Q = 14 + 2Q gives Q = 2 and price 22. TR = 44 and TC = 52, so the loss is £8. AVC = 14 + 2 = 16 is below the price of 22, so the firm still covers variable cost. Closing would lose the fixed cost of £20, which is worse.

Must-know distinctions

• Movement along LRAC (internal) versus shift of LRAC (external).
• MES versus the output of lowest SRAC on one plant.
• Normal profit (inside costs) versus supernormal (above costs).
• Accounting versus economic profit.
• MR versus AR: for a price-setting firm, MR is below AR.

Quick self-test

1. Define minimum efficient scale.
2. LRTC is £90,000 at 10,000 units and £138,000 at 20,000 units. State LRAC at each and the percentage change.
3. Rival firms gain from a trained workforce built up by the growth of their industry. Is this an internal or external economy?
4. A firm faces P = 50 − 2Q. Find TR and MR at 10 units.
5. Find PED at 10 units for this firm.
6. At what output is TR highest?
7. Revenue is £80,000, explicit costs £55,000 and implicit costs £22,000. Find accounting and economic profit.
8. Output is 200 units at AR £15 and AC £18. Find the profit or loss.
9. At output 40, MR is £22 and MC is £19. Should the firm change output?
10. A market takes 90,000 units and MES is 15,000. What is the largest number of firms that could each reach MES?

Answers

1. The smallest output at which LRAC reaches its lowest value.
2. 90,000/10,000 = £9.00 and 138,000/20,000 = £6.90. Change = (6.90 − 9.00)/9.00 × 100 = −23.3%.
3. External: it arises from the industry’s growth and shifts LRAC down.
4. P = 30, so TR = 300. MR = 50 − 4 × 10 = 10.
5. −(1/2) × (30/10) = −1.5, which is elastic.
6. Where MR = 0: 50 − 4Q = 0, so Q = 12.5.
7. Accounting profit 80,000 − 55,000 = £25,000. Economic profit 25,000 − 22,000 = £3,000.
8. TR = 3,000 and TC = 3,600, so a loss of £600.
9. Yes, produce more: MR exceeds MC by £3, so another unit adds to profit.
10. 90,000/15,000 = 6 firms.

Where marks are usually lost

• Calculating percentage change from the new value instead of the old.
• Giving a figure for MR without showing the working that leads to it.
• Mixing up a movement along LRAC with a shift of it.
• Treating economies of scale as automatic gains for consumers.
• Describing MES with no reference to market size.
• Calling accounting profit supernormal profit.
• Drawing MC = MR but reading price from the MC curve instead of AR.
• Listing causes of economies of scale with no evaluation of size or timing.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021.