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

This guide follows the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. It covers the part of the Competition and market power area of study, in Component 1 Microeconomics, that deals with the long run, revenue and profit. The whole specification is A Level and the text labels no content as AS or Extension. Every figure below is invented and illustrative.

Start from the Microeconomics overview, the OCR Economics hub and the printable checklist. Elasticity has its own guide. Check your level with the free diagnostics. Companion pages: revision notes and practice questions.

Coverage

Outcome	You must be able to
SRAC and LRAC	Explain how they relate
Economies and diseconomies	Explain internal and external types, evaluate causes and significance
MES	Explain it and evaluate its importance
Revenue	Explain and calculate TR, AR, MR, and link price, revenue, PED and output
Profit	Calculate profit or loss, distinguish accounting from economic profit, explain supernormal, normal and loss
MC = MR	Explain with diagrams why profit is maximised (loss minimised) there

1. Short run and long run average cost

The short run is a period in which some factor cannot be changed. In the long run all factors are variable, so the firm can choose any plant size. Each plant size has its own short run average cost curve (SRAC).

The long run average cost curve (LRAC) traces the cheapest cost per unit of each output once the firm can pick the best plant. It is the envelope of the SRAC curves: it touches each and never lies above any.

Worked example 1. A furniture maker in a fictional economy can build one of four plant sizes. The table gives SRAC in pounds per unit (illustrative).

Output	Plant A	Plant B	Plant C	Plant D	LRAC
200	12.00	13.00	23.50	44.00	12.00
300	13.00	10.00	16.50	33.00	10.00
400	16.00	9.00	11.50	24.00	9.00
500	21.00	10.00	8.50	17.00	8.50
600	28.00	13.00	7.50	12.00	7.50
800	48.00	25.00	11.50	8.00	8.00

At each output the LRAC is the lowest figure in the row. Between 200 and 600 units it falls by (7.50 − 12.00)/12.00 × 100 = −37.5%. Between 600 and 800 it rises by (8.00 − 7.50)/7.50 × 100 = +6.7%. With only four plant sizes the envelope is scalloped. With every size available it would be a smooth U-shape.

A firm already on a plant moves only along that SRAC in the short run, so it can sit above the LRAC.

2. Internal economies and diseconomies of scale

Internal economies of scale are falling LRAC as the firm itself grows (a movement along LRAC). Sources:

• Technical: large machines and production lines, and the spreading of equipment cost over many units.
• Purchasing: discounts on bulk orders.
• Managerial: specialist managers become affordable.
• Financial: large firms often borrow at lower interest rates.
• Marketing: one advertising budget is spread over many more units.
• Risk-bearing: a wider range of products or markets reduces dependence on one.

Worked example 2. Fixings cost £4.00 a kilogram, with 12% off orders above 10,000 kg. The discounted price is 4.00 × 0.88 = £3.52, so on 15,000 kg the saving is 15,000 × 4.00 × 0.12 = £7,200. Only a large firm gets this purchasing economy.

Internal diseconomies are rising LRAC as the firm grows too large. Causes: control and coordination problems as management layers multiply, poor communication, and falling motivation as workers feel distant from decisions.

Worked example 3. Moving from plant C to D, output rises from 600 to 800 (+33.3%) but total cost rises from 600 × 7.50 = £4,500 to 800 × 8.00 = £6,400 (+42.2%). Costs rise faster than output: diseconomies.

3. External economies and diseconomies

External economies arise when the whole industry expands, not one firm: a pool of skilled labour, specialist suppliers nearby, shared transport links. They shift every firm’s LRAC down.

External diseconomies also come from industry growth: congestion, rising rents and wages bid up by competing employers. They shift every LRAC up.

Worked example 4. Congestion raises delivery costs by 10% and deliveries are 25% of the furniture maker’s costs. Average cost rises by 0.25 × 10% = 2.5%. A cost of £7.50 becomes 7.50 × 1.025 = £7.69. The whole LRAC curve shifts up.

4. Evaluating causes and significance

For the causes, ask how likely each source is and what limits it.

• Technical economies need heavy investment and enough demand to use the capacity.
• Diseconomies are not inevitable. Delegation, better information systems and divisions can postpone them.
• Time matters: economies often take years to appear, while the costs of expansion arrive at once.

For significance, consider each economic agent.

• Firms: lower cost allows lower prices or higher profit and a cost advantage over smaller rivals. It is also a barrier to entry, since a new entrant starts small with higher costs.
• Consumers: gain only if the saving is passed on as lower prices.
• Workers: growth can create jobs, but mergers can lead to redundancies.
• Government: may need to monitor firms whose scale gives them power over price.

Reach a judgement: significance depends on how much of the saving reaches consumers.

5. Minimum efficient scale

Minimum efficient scale (MES) is the first output at which the LRAC has fallen as far as it will go. By MES the firm has exploited all the available economies of scale.

In worked example 1 the lowest LRAC in the table is £7.50, first reached at 600 units, so MES is 600 units.

Its importance lies in comparison with market size.

• If the market buys 7,200 units, 7,200/600 = 12 firms could each operate at MES, so many competitors can survive at low cost.
• If the market buys 1,000 units, there is room for 1,000/600 = 1.67 firms. One firm has a decisive cost advantage and the market tends towards monopoly.
• A firm producing 300 units has LRAC £10.00, (10.00 − 7.50)/7.50 × 100 = 33.3% above the best achievable, so it struggles to match a larger rival’s price.

Evaluation: if LRAC is flat over a wide range, firms of different sizes can survive.

6. Total, average and marginal revenue

• Total revenue (TR) is the money received from all sales: price multiplied by units sold.
• Average revenue (AR) is takings per unit, equal to the price, so the AR curve is the demand curve the firm faces.
• Marginal revenue (MR) is the addition to TR from one extra unit sold.

Worked example 5. A firm faces the demand curve P = 90 − 3Q, so AR = 90 − 3Q and TR = 90Q − 3Q². The MR formula is 90 − 6Q: same intercept, twice the slope.

Output	Price = AR	TR	MR of that unit
1	87	87	87
2	84	168	81
3	81	243	75
4	78	312	69

For the third unit, MR = 243 − 168 = 75. The formula at 2.5 units gives 90 − 15 = 75, matching.

On the diagram (price and revenue up the side, output along the base), AR runs from 90 at zero output down to 0 at output 30. MR runs from 90 down to 0 at output 15, which is where TR is at its maximum.

7. Price, revenue, PED and output

On a straight-line demand curve, PED falls in absolute size as output rises. Use point elasticity: PED = (change in Q/change in P) × (P/Q). Here Q = (90 − P)/3, so the slope term is −1/3.

Output	Price	TR	PED	MR	Demand is
9	63	567	−(1/3) × 63/9 = −2.33	36	elastic
15	45	675	−(1/3) × 45/15 = −1.00	0	unit elastic
20	30	600	−(1/3) × 30/20 = −0.50	−30	inelastic

The link is MR = P(1 + 1/PED). At 9 units: 63 × (1 − 0.4286) = 36, which matches 90 − 54.

Check by price change. Cutting price from 63 to 54 raises output from 9 to 12 and TR from 567 to 648 (elastic). Cutting from 36 to 30 raises output from 18 to 20 but TR falls from 648 to 600 (inelastic).

In words: where demand is elastic, MR is positive and lowering price raises TR. At unit elasticity, MR is zero and TR is at its maximum. Where demand is inelastic, MR is negative, so a firm whose extra output adds to cost will not operate there.

8. Profit, loss, and accounting versus economic profit

Profit equals TR − TC, and a negative figure is a loss. Per unit, profit equals AR − AC.

Accounting profit is TR minus explicit costs, the payments the firm makes. Economic profit is TR minus explicit and implicit costs. Implicit costs are the opportunity cost of resources the owner supplies, such as time and own capital.

Worked example 6. Hearth Bakery (illustrative) has revenue £210,000. Ingredients cost £70,000, wages £62,000 and rent and utilities £28,000, so explicit costs are £160,000. Accounting profit = 210,000 − 160,000 = £50,000.

The owner could earn £34,000 elsewhere and has £120,000 of savings in the business that could earn 6% (£7,200). Implicit costs = 34,000 + 7,200 = £41,200. Economic profit = 50,000 − 41,200 = £8,800.

If revenue falls to £195,000, accounting profit is £35,000 but economic profit is −£6,200: the accounts show a profit while the owner would be better off elsewhere.

9. Supernormal profit, normal profit and loss

Normal profit is the least return that stops the owner moving resources to another use. Economists treat it as an implicit cost, so it sits inside TC.

Case	Condition	AR and AC	Economic profit
Supernormal (abnormal) profit	TR > TC	AR > AC	Positive, above normal
Normal profit	TR = TC	AR = AC	Zero
Loss	TR < TC	AR < AC	Negative, below normal

Worked example 7. Three firms (illustrative):

Firm	Output	AR	AC	TR	TC	TR − TC
X	400	12	10	4,800	4,000	+800
Y	500	9	9	4,500	4,500	0
Z	300	8	11	2,400	3,300	−900

On an AR and AC diagram, supernormal profit is the rectangle of height AR − AC and width equal to output: for firm X, (12 − 10) × 400 = 800. Firm Z has a loss rectangle (11 − 8) × 300 = 900.

10. Profit maximisation at MC = MR

A profit-maximising firm compares the extra revenue from one more unit (MR) with its extra cost (MC). If MR > MC the unit adds to profit; if MC > MR it reduces profit. Profit is highest at the output where MC = MR and the MC curve cuts MR from underneath.

Worked example 8. Demand is P = 90 − 3Q. Total cost is TC = 72 + 18Q + Q², so MC = 18 + 2Q.

Output	Price	TR	TC	Profit	MR	MC
8	66	528	280	248	45	33
9	63	567	315	252	39	35
10	60	600	352	248	33	37

Set MR = MC: 90 − 6Q = 18 + 2Q, so 8Q = 72 and Q = 9. Price = 90 − 27 = 63. Profit = 567 − 315 = £252. Check: AC = 315/9 = 35, so (63 − 35) × 9 = 252. The tenth unit adds MR 33 but MC 37, so profit falls.

Loss minimisation. Demand falls to P = 42 − 3Q, so MR = 42 − 6Q. Setting 42 − 6Q = 18 + 2Q gives Q = 3, price 33. TR = 99, TC = 72 + 54 + 9 = 135, so the loss is £36. MC = MR still gives the smallest loss. It is below the £72 fixed cost lost by closing, because price 33 exceeds AVC of 21.

Common errors

• Writing that MR is the price. Only with a horizontal AR curve does MR equal AR.
• Counting normal profit as a surplus above costs.
• Saying accounting profit must mean supernormal profit.
• Describing MES as the largest efficient output rather than the smallest at minimum LRAC.

Official syllabus

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