Fixed vs variable costs; TC, AC, MC
Fixed costs (FC) do not change with output in the short run (rent, loan repayments, insurance). Variable costs (VC) change with output (raw materials, piece-rate wages). Total cost TC = FC + VC. Average cost AC = TC ÷ Q (cost per unit). Marginal cost (MC) is the extra cost of one more unit. The FC/VC split explains why AC falls as output rises — the same fixed cost is spread over more units — and why the AC curve is U-shaped.
Revenue: TR, AR and MR
Total revenue TR = P × Q. Average revenue AR = TR ÷ Q = P (in a competitive market AR equals the price). Marginal revenue (MR) is the extra revenue from selling one more unit. A profit-maximising firm produces where MC = MR (developed in the market-structures topics). Watch the classic trap: TR is not profit — it is revenue before any costs are deducted.
Profit = TR - TC; normal vs supernormal
Total profit = TR - TC. Normal profit is the minimum return needed to keep a firm in its industry — an opportunity cost, so it is included within TC. When TR = TC (including normal profit) the firm earns exactly normal profit and breaks even in the economic sense. Supernormal profit (abnormal profit) arises when TR > TC including that normal return. When TR < TC the firm makes a loss. Confusing normal profit with zero profit is a frequent error.
Drawn from real examiner reports.
Total revenue is not profit
A recurring error is equating TR (total revenue) with profit. Revenue is income from sales before any costs are paid; profit only arises after all costs (fixed and variable) are subtracted: profit = TR - TC. Defining profit as "the money a firm receives" scores nothing on the definition and produces wrong answers in calculation questions.
November 2024 Paper 1, Q2(c): candidates confused total revenue with profit, failing to subtract total cost.
Divide cost by quantity, not price
Average cost AC = TC ÷ Q, where Q is the number of units produced. A significant number of candidates divided total cost by total revenue or by price instead of by output, which produces a dimensionless ratio with no economic meaning. Always use units of output as the denominator: AC = total cost ÷ units produced.
June 2024 Paper 1, Q2(b): candidates frequently divided total cost by total revenue or by price instead of by quantity.
Normal profit is not zero profit
Normal profit is the return necessary to keep a firm in its line of production — an implicit cost (the opportunity cost of enterprise and capital). When TR = TC (TC including normal profit) the firm earns exactly normal profit and stays open. Only when TR exceeds that TC is there supernormal profit. Treating normal profit as "no profit" wrecks entry and exit analysis.
June 2024 Paper 1, Q2(d): widespread confusion between normal profit and zero profit — candidates failed to identify normal profit as a cost.
Average cost includes fixed costs
AC (average cost) is TOTAL cost ÷ Q, not variable cost per unit. Total cost = fixed + variable costs, so overheads like rent and loan repayments are part of AC. Working out AC from variable costs alone understates the true cost per unit and distorts any break-even or profit figure. Always add FC and VC before dividing by output.
Supernormal profit is not permanent
Assuming a firm keeps its supernormal profit forever is wrong. In a competitive market with low barriers to entry, supernormal profit (TR > TC) is a signal that attracts new firms. As they enter, supply rises and price falls, so the supernormal profit is competed away until only normal profit remains in the long run.
Average revenue vs average cost
AR and AC are easy to swap. Average revenue AR = TR ÷ Q, and equals price in a competitive market. Average cost AC = TC ÷ Q. AR uses total REVENUE as the numerator; AC uses total COST. Profit per unit = AR - AC. Mixing the two numerators gives a meaningless figure and loses the calculation marks.
Scaffold for extended questions
Long questions follow a scaffold: define the term (AO1), apply it to the firm or data (AO2), develop a chain from concept to outcome (AO3), and — for Assess/Evaluate — weigh a counter-point and reach a supported judgement (AO4). Description alone misses AO3.
Analyse is one-sided
Analyse carries no AO4 (evaluation) marks, so counter-arguments and judgements waste time. Build two or three sustained chains on ONE side — point, because, therefore — each applied to the data. Save the two-sided balance for Assess, Evaluate and Discuss.
Show working and label the units
In Calculate questions show every step and state units (£, £ per unit, %). For average cost or revenue, divide by QUANTITY, never by price or revenue. For percentage change, use the ORIGINAL value as the base and multiply by 100. Method marks survive a wrong final figure.
Match command word to the mark tariff
Match the command word to the tariff. Define (2 marks) = the meaning only. Explain (4-6) = define, apply, show the mechanism. Analyse (9) = one-sided chains. Assess/Evaluate (12) = both sides plus a supported judgement. Read the marks before you plan the depth.
Fixed costs (FC) do not change as output changes in the short run. Examples: rent, loan repayments, insurance premiums, management salaries.
Variable costs (VC) change directly with the level of output. Examples: raw materials, packaging, piece-rate labour.
Marginal cost (MC) = the extra cost of producing one more unit of output. As output rises, MC typically falls first (due to specialisation) then rises (due to the law of diminishing returns).
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