In simple terms
A friendly intro before the formal notes — no formulas yet.
Types of cost, revenue and profit, short run and long run production
9708 AS costs and revenue — fixed/variable, SR/LR curves, and profit maximisation.
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Short Run: At least one factor of production is fixed.
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Fixed Costs (FC): Costs that do not vary with output (e.g., rent, insurance).
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Variable Costs (VC): Costs that vary directly with output (e.g., raw materials, wages for production staff).
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Total Cost (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC).
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Fixed vs variable costs
Fixed vs variable costs — FC do not vary with output.
Key formulas
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At a glance — side by side
Compare key properties side by side — ideal for exam contrasts.
Comparison of Short Run and Long Run Production Periods
| Feature | Short Run | Long Run |
|---|---|---|
| Definition | A period of time where at least one factor of production is fixed. | A period of time where all factors of production are variable. |
| Factor Inputs | Contains both fixed factors (e.g., capital) and variable factors (e.g., labour). | All factors are variable; the firm can change its entire scale of operation. |
| Key Economic Concept | The Law of Diminishing Marginal Returns. | Economies and Diseconomies of Scale. |
| Relevant Cost Curves | Short-Run Average Cost (SRAC), Average Variable Cost (AVC), Marginal Cost (MC). | Long-Run Average Cost (LRAC) and Long-Run Marginal Cost (LRMC). |
Definition
Short Run
Long Run
Factor Inputs
Short Run
Long Run
Key Economic Concept
Short Run
Long Run
Relevant Cost Curves
Short Run
Long Run
Full topic notes
Formal explanation with the rigour you need for the exam.
1. Short-Run Production and Costs
In economics, the short run is a period of production where at least one factor of production is fixed, while others are variable. Typically, capital (like a factory or machinery) is considered fixed, whereas labour and raw materials are variable. Total Fixed Costs (TFC) do not change with output, whereas Total Variable Costs (TVC) increase as more output is produced. Total Cost (TC) is the sum of TFC and TVC. The concept underpinning short-run cost curves is the Law of Diminishing Marginal Returns, which states that as more units of a variable factor (e.g., labour) are added to a fixed factor (e.g., capital), there will come a point where the marginal product of the variable factor begins to decrease, leading to rising marginal costs.
Short Run: At least one factor of production is fixed.
Fixed Costs (FC): Costs that do not vary with output (e.g., rent, insurance).
Variable Costs (VC): Costs that vary directly with output (e.g., raw materials, wages for production staff).
Total Cost (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC).
The Law of Diminishing Marginal Returns explains the shape of short-run cost curves.
2. Short-Run Average and Marginal Cost Curves
From total costs, we derive average and marginal costs, which are crucial for firm decision-making. Average Fixed Cost (AFC) continuously falls as output increases because the fixed cost is spread over more units. Average Variable Cost (AVC) and Average Total Cost (ATC) are typically U-shaped due to the law of diminishing returns. Initially, they fall due to increasing returns, but eventually rise as diminishing returns set in. Marginal Cost (MC) is the additional cost of producing one more unit. The MC curve also falls initially before rising steeply. A critical relationship exists where the MC curve intersects both the AVC and ATC curves at their respective minimum points. This is a mathematical certainty that is frequently tested.
Average Total Cost (ATC) = TC / Quantity (Q)
Average Variable Cost (AVC) = TVC / Q
Average Fixed Cost (AFC) = TFC / Q
Marginal Cost (MC) = Change in TC / Change in Q
The MC curve cuts the ATC and AVC curves at their lowest points.
Be prepared to draw and label the short-run cost curve diagram accurately. Show AFC falling, and the U-shaped AVC, ATC and MC curves. Ensure your MC curve cuts ATC and AVC at their minimum points. Marks are often lost for inaccurate diagrams.
3. Long-Run Production and Economies of Scale
The long run is a time period where all factors of production are variable; a firm can change its entire scale of operation. The Long-Run Average Cost (LRAC) curve shows the minimum possible average cost for any given level of output when all factors are variable. It is often called an 'envelope curve' as it is composed of a series of Short-Run Average Cost (SRAC) curves. The downward-sloping part of the LRAC illustrates economies of scale, where average costs fall as output rises. These can be internal (e.g., technical, financial, managerial) or external (e.g., industry growth). The upward-sloping part shows diseconomies of scale, where average costs rise due to issues like communication problems and loss of control in large firms.
Long Run: All factors of production are variable.
The LRAC curve is an 'envelope' of the SRAC curves.
Economies of Scale: LRAC falls as output increases. Sources include technical, purchasing and financial economies.
Diseconomies of Scale: LRAC rises as output increases, often due to problems of management and coordination.
Constant Returns to Scale: LRAC is constant as output increases.
4. Revenue and Profit Maximisation
Total Revenue (TR) is the total income from selling a given quantity of output (Price x Quantity). Average Revenue (AR) is revenue per unit (TR/Q), which is always equal to the price. Marginal Revenue (MR) is the extra revenue from selling one more unit. Economists assume the primary objective of a firm is profit maximisation. This occurs at the output level where Marginal Cost (MC) equals Marginal Revenue (MR). If MR > MC, the firm can increase profit by producing more. If MC > MR, the firm is making a loss on the last unit and should reduce output. The profit-maximising equilibrium is therefore always at MC = MR. This rule is fundamental to all market structure analyses.
Total Revenue (TR) = Price (P) x Quantity (Q).
Average Revenue (AR) = TR / Q = Price. The AR curve is the firm's demand curve.
Marginal Revenue (MR) = Change in TR / Change in Q.
The profit maximisation rule is to produce at the output level where MC = MR.
Normal profit is the minimum level of profit needed to keep a firm in an industry (TR = TC). Supernormal profit is any profit above this level (TR > TC).
Cost concepts
Total cost (TC) = Total fixed cost (TFC) + Total variable cost (TVC)
Average fixed cost (AFC) = TFC/Q — falls continuously as output rises.
Average variable cost (AVC) = TVC/Q — U-shaped in the short run.
Average cost (AC) = TC/Q = AFC + AVC — U-shaped.
Marginal cost (MC) = ΔTC/ΔQ — cuts AVC and AC at their minimum points.
,
Profit-maximising output:
Short-run and long-run production
Short run: at least one factor is fixed (usually capital). Diminishing marginal returns cause MC and AVC to rise eventually.
Long run: all factors variable. The LRAC curve is a planning curve showing the lowest AC for each output level. It is U-shaped due to economies of scale (falling LRAC) then diseconomies of scale (rising LRAC).
Minimum efficient scale (MES): output at the bottom of the LRAC — lowest unit cost.
Worked examples
See the formulas applied — reveal one step at a time, like the exam.
A firm in a perfectly competitive market faces P = MR = £12. Its costs are:
| Q | TC (£) |
|---|---|
| 0 | 20 |
| --- | --- |
| 1 | 28 |
| 2 | 34 |
| 3 | 42 |
| 4 | 54 |
| 5 | 70 |
(a) Calculate MC at each output level. (b) Find profit-maximising output and total profit.
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(a) MC = ΔTC/ΔQ:
A small bakery has total fixed costs (TFC) of $60 per day. Its total variable costs (TVC) for different quantities of cakes are given in the table below.
| Quantity (Q) | TVC ( |--------------|---------|
| 0 | 0 |
|---|---|
| 1 | 30 |
| 2 | 50 |
| 3 | 60 |
| 4 | 80 |
| 5 | 110 |
| 6 | 150 |
Calculate the Total Cost (TC), Average Fixed Cost (AFC), Average Variable Cost (AVC), Average Total Cost (AC), and Marginal Cost (MC) for each level of output from 1 to 6 cakes. Identify the output level where AC is at its minimum.
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First, we set up a table to calculate each cost component. Remember:
- TFC = $60 (constant)
- TC = TFC + TVC
- AFC = TFC / Q
- AVC = TVC / Q
- AC = TC / Q (or AFC + AVC)
- MC = ΔTC / ΔQ
How it all connects
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Glossary
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Quick check
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Revision flashcards
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Fixed vs variable costs?
Fixed costs (FC) do not change with output (e.g. rent). Variable costs (VC) change with output (e.g. raw materials). TC = TFC + TVC.
Key takeaways
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Short Run: At least one factor of production is fixed.
- ✓
Fixed Costs (FC): Costs that do not vary with output (e.g., rent, insurance).
- ✓
Variable Costs (VC): Costs that vary directly with output (e.g., raw materials, wages for production staff).
- ✓
Total Cost (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC).
- ✓
The Law of Diminishing Marginal Returns explains the shape of short-run cost curves.
Practice — then mark it
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Mark a costs and revenue question
Mark a costs and revenue question
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