OxfordAQA A-level Economics: Costs of production, economies of scale, revenue and profit (9640) – Revision Notes

Short-form notes on the OxfordAQA International AS and A-level Economics specification (9640), version 1.2, sections 3.1.3.3 to 3.1.3.5: costs of production, economies and diseconomies of scale, and average revenue, total revenue and profit. Section 3.1 is International AS content and forms part of the full International A-level. Fuller explanations sit in the study guide. Practise with the practice questions, use the checklist, see the course hub and try the free 10-minute diagnostics. Every figure here is made up.

3.1.3.3 Costs of production

Key definitions

Term	Meaning
Short run	one or more inputs are locked in
Long run	every input can be varied, so scale can change
Fixed cost	stays the same whatever the output while the short run lasts (rent, insurance); owed even at zero output
Variable cost	varies with output (materials, extra hours of labour)
Total cost (TC)	FC + VC
Average cost (AC)	TC ÷ output; equals AFC + AVC

Formulas

Measure	Formula
AFC (fixed cost per unit)	FC ÷ Q
AVC (variable cost per unit)	VC ÷ Q
AC	TC ÷ Q, or AFC + AVC
TC from AC	AC × Q
VC	TC − FC

Method in steps: completing a cost table

1. Write FC (it stays the same on every row).
2. Find VC as TC − FC, or TC as FC + VC.
3. Divide FC, VC and TC by output for AFC, AVC and AC.
4. Check that AFC + AVC = AC.
5. Look for the lowest AC and describe the shape.

Worked reminder

A dairy has FC of 900 and VC of 1,500 at 600 litres. TC = 900 + 1,500 = 2,400. AC = 2,400 ÷ 600 = 4.00. AFC = 900 ÷ 600 = 1.50. AVC = 1,500 ÷ 600 = 2.50. Check: 1.50 + 2.50 = 4.00.

Shape of the short-run AC curve

• AFC falls with every extra unit, since the fixed bill is divided among more output.
• AVC usually falls and then rises.
• Result: the short-run AC curve is likely to be U-shaped. The specification asks you to appreciate this; it does not expect a formal link to the law of diminishing returns here (that is in Unit 3).

Must-know distinctions

• Fixed versus variable: ask “does it change if output changes?” in the short run.
• Total versus average: a fall in AC can still mean a rise in TC.
• A rise in fixed cost raises AFC and AC but not AVC.
• Short-run AC shape versus long-run AC shape: they have different explanations.

A2 only (QS6): marginal cost = change in TC for one more unit. Example: TC rises from 340 to 380 when output goes from 20 to 21, so marginal cost is 40.

3.1.3.4 Economies and diseconomies of scale

Internal economies (growth of the firm)

Type	Example
Technical	a larger oven or production line that costs less per unit
Purchasing	lower price per unit on bulk orders
Managerial	specialist managers for finance or logistics
Financial	cheaper borrowing for a larger firm
Marketing	advertising cost spread over more sales

External economies (growth of the industry or area)

• A skilled labour pool in a region where many firms operate.
• Specialist suppliers and repairers move nearby.
• Training colleges, roads, ports and other infrastructure built because the industry is large.

Diseconomies of scale

• Co-ordination and communication problems as layers of management grow.
• Loss of control and monitoring.
• Lower worker motivation in a very large organisation.
• Duplication of departments or sites.

The LRAC curve

Region of LRAC	Meaning
Falling	economies of scale
Flat	neither economies nor diseconomies
Rising	diseconomies of scale

Minimum efficient scale (MES): the smallest output that reaches the lowest LRAC.

Feature	Internal	External
Caused by	the firm’s own growth	the industry’s or area’s growth
Shown by	movement along the LRAC curve	downward shift of the LRAC curve

Worked reminder: percentage change in LRAC

LRAC falls from 8.0 to 6.4 when output doubles from 100 to 200. Change = (6.4 − 8.0) ÷ 8.0 × 100 = −20.0%. As an index with the first value as 100: 6.4 ÷ 8.0 × 100 = 80.0.

Method in steps: reading an LRAC table

1. Find the lowest LRAC; the lowest output at that value is MES.
2. Mark where LRAC falls (economies), stays level (constant) and rises (diseconomies).
3. Work out total cost as LRAC × output when you need it.
4. For a percentage change, use (new − old) ÷ old × 100.
5. Link each region to a cause, not just a label.

Worked reminder: bulk-buying and average cost

A supplier cuts its price from 5.00 to 4.50 a unit on an order of 2,000 units: saving 2,000 × 5.00 − 2,000 × 4.50 = 1,000, a 10% fall in that input’s price. If that input is 4.00 of an average cost of 8.00, it falls to 4.00 × 0.90 = 3.60, so AC becomes 8.00 − 4.00 + 3.60 = 7.60, a fall of 5.0%.

Chain of reasoning for an economy of scale

Larger output, so a bulk order, so a lower price per unit from the supplier, so a lower average cost, so (if the saving is passed on) a lower price or a higher profit per unit. State each link; the middle link is the one that is often missing.

Evaluation checklist

• Is the firm already at MES?
• Is demand big enough to use the extra capacity?
• Are there up-front costs and time lags?
• Could diseconomies set in?
• Are lower costs passed on to consumers?

3.1.3.5 Average revenue, total revenue and profit

Measure	Formula
TR	selling price × units sold
AR	TR ÷ quantity (the same as price when every unit sells at one price)
Profit	TR − TC
Profit per unit	AR − AC
Loss	TC > TR

The AR curve is the firm’s demand curve. A change in price moves the firm along the curve. A change in a non-price factor shifts it.

Worked reminder

AR is 18 and quantity is 250. TR = 18 × 250 = 4,500. TC is 3,900, so profit = 4,500 − 3,900 = 600. AC = 3,900 ÷ 250 = 15.60. Profit per unit = 18 − 15.60 = 2.40, and 2.40 × 250 = 600.

Method in steps: finding profit

1. Find TR: price × quantity, or AR × quantity.
2. Find TC: FC + VC, or AC × quantity.
3. Subtract: profit = TR − TC. A negative answer is a loss.
4. Check with AR − AC per unit, multiplied by quantity.
5. Break-even output is where revenue just covers costs (TR = TC) and profit is nil.

Why average revenue traces demand

Whatever the price, buyers choose how many units to take, and the firm sells exactly that. So price (which is AR) plotted against quantity traces the demand curve. If demand rises, the AR curve shifts right: more is sold at each price, or a higher price is paid for each quantity.

Must-know distinctions

• Revenue is not profit.
• Higher revenue can come with lower profit if costs rise faster.
• Average and total are different measures: report units.

A2 only (QS6): marginal revenue = change in TR for one more unit. If TR rises from 4,500 to 4,516 when output goes from 250 to 251, marginal revenue is 16.

Quick self-test

1. State what makes a cost fixed.
2. A firm’s total cost is 5,000 at 250 units. Find AC.
3. FC is 600. Find AFC at 40 units and at 60 units, and say what the change shows.
4. VC is 1,800 at 120 units. Find AVC.
5. A college opens near a cluster of firms and trains the skills they need. Internal or external economy?
6. Give one cause of diseconomies of scale.
7. TR is 2,520 for 84 units. Find AR.
8. TR is 6,300 and TC is 5,850. Find profit.
9. Which cost-and-revenue curve is the firm’s demand curve?
10. LRAC falls from 10.0 to 8.5. Find the percentage change.
11. Price is 25, AC is 27.50 and 80 units are sold. State the profit or loss.

Answers

1. It does not change with output in the short run.
2. 5,000 ÷ 250 = 20.
3. 600 ÷ 40 = 15; 600 ÷ 60 = 10. AFC drops because the fixed bill is shared among more units.
4. 1,800 ÷ 120 = 15.
5. External economy: it benefits all firms in the area.
6. Any one: communication problems, loss of control, lower motivation, duplication.
7. 2,520 ÷ 84 = 30.
8. 6,300 − 5,850 = 450.
9. The average revenue (AR) curve.
10. (8.5 − 10.0) ÷ 10.0 × 100 = −15%.
11. Loss per unit = 25 − 27.50 = −2.50. Loss = 2.50 × 80 = 200.

Where marks are usually lost

• Calling AC “average cost” but dividing by the wrong quantity.
• Forgetting to subtract fixed cost to get VC.
• Leaving out units or the minus sign for a loss or a fall.
• Explaining the U-shape of the short-run AC curve with economies of scale.
• Calling an internal example external, or the reverse.
• Listing diseconomies without saying why unit costs rise.
• Treating a revenue rise as a profit rise.
• Giving an economy of scale without saying how it lowers the cost per unit.

Official syllabus

Source document: the OxfordAQA specification for International AS and A-level Economics (9640), version 1.2: sections 3.1.3.3 to 3.1.3.5 and quantitative skills in 3.5.