Costs of Production

Fixed costs
 Fixed costs (FC) are costs that are fixed in the short-term running of a
business and have to be paid even when no production is taking place.
 Examples: rent, interest on bank loans, telephone bills. These costs do not
depend on the amount of output produced.
 Average fixed cost (AFC) refers to a firm’s fixed cost per unit of output.
¿
 Average ¿ Cost ( AFC )=Total ¿ Cost Total Output

Variable costs
  Variable costs (VC) are costs that are variable in the short-term running of
a business and are paid according to the output produced. The more the
production, the more the variable costs are.
 Examples: wages, electricity bill, cost of raw materials.
 Average Variable costs (AVC) refers to the variable cost per unit of output.
Total Variable Costs
 Average Variable Cost ( AVC )=
Total Output

OR

NOTE: Variable costs are only in the short-run; in the long run all
costs are fixed.

Total costs
  Total cost (TC) is the sum of all fixed and variable costs of production.
 Total Costs (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC)

This is a simple graph showing the relation between TC, FC and VC. The gap
between the TC and TVC indicates the TFC. The gap between TC and TFC indicated
TVC.

 Average Total Cost (ATC) is the cost per unit of output, i.e., the total cost of
making one product.
Total cost
 Average Total cost ( ATC )= OR
Total Output
 Average total Cost (ATC) = Average Variable Cost (AVC) + Average Fixed Cost (AFC)

(Remember: ‘average’ means ‘per

unit’ and so will involve dividing the particular cost by the total output
produced. In the graph above you will notice that the average total costs (and
average variable costs and if it was drawn) first fall and then start rising. This is
because of economies of scale and diseconomies of scale respectively. As the firm
increases its output, the average costs decline but as it starts growing beyond a
limit, the average costs rise).

Q/ Suppose a TV manufacturer produces 1000 TVs a month. The firm’s

fixed costs in rent is $900, and variable cost per unit is $500. What
would its TFC, TVC, AVC, AFC, AC and TC be, in a month?
No. of units of TVs produced = 1000

Total Fixed Costs for one month = $900

Average Fixed Cost = $900 / 1000 = $0.9 per unit

Variable Cost of producing one unit of TV = $500

Total Variable Costs for producing 1000 TVs in a month = $500 * 1000 = $500,000
Average Variable Cost = $500,000 / 1000 = $500 (AVC is the same as VC per unit!)

Total Costs = Total Fixed Costs + Total Variable Costs ==> $900 + $500,000 =
$500,900

Average Costs = Total Costs / Total Output ==> $500,900 / 1000 = $500.9
or Average Costs = AFC + AVC ==> $0.9 + $500 ==> $500.9

Revenue
  Revenue is the total income a firm earns from the sale of its goods and
services.
 The more the sales, the more the revenue.
 Total Revenue ( TR )=No . of units sold ( Sales ) × Price per unit ( P )
Total Revenue
 Average Revenue= [= Price per unit (P)]
No . of units sold ( Sales )

Q/ Suppose from the example above, a TV is sold at $800, and the firm sells
all the units it produces, what is the firm’s Total Revenue and Average
Revenue, for a month?

No. of units sold (Sales) in a month = No. of units produced in a month = 1000

Total Revenue = Sales * Price ==> 1000 * $800 = $800,000

Average Revenue = Total Revenue / Sales = $800,000 / 1000 = $800

Profit=Total Revenue – Total Cost

NOT IN SYLLABUS, USE FOR INTERNAL EXAMS

FOR COMPETITIVE MARKETS

FOR MONOPOLIES

Objectives of Firms
  Objectives vary with different businesses due to size, sector and many
other factors. However, many businesses in the private sector aim to
achieve the following objectives.
 Survival: new or small firms usually have survival as a primary objective.
Firms in a highly competitive market will also be more concerned with
survival rather than any other objective. To achieve this, firms could
decide to lower prices, which would mean forsaking other objectives
such as profit maximization.
 Profit maximasiation: profit is the income of a business from its
activities after deducting total costs from total revenue. Private sector
firms usually have profit making as a primary objective. This is because
profits are required for further investment into the business as well as
for the payment of return to the shareholders/owners of the business.
Usually, firms aim to maximise their profits by either minimising costs,
or maximising revenue, or both.
 Growth: once a business has passed its survival stage it will aim for
growth and expansion. This is usually measured by value of sales or
output. Aiming for business growth can be very beneficial. A larger
business can ensure greater job security and salaries for employees. The
business can also benefit from higher market share and economies of
scale.
 Service to the society: Some operations in the private sectors such as
social enterprises do not aim for profits and prefer to set more social
objectives. They include having ethical objectives and using moral
principles (values and beliefs) to guide business activity.
 EXTRA: (Market share: market share can be defined as the sales in
proportion to total market sales achieved by a business. Increased
market share can bring about many benefits to the business such as
increased customer loyalty, setting up of brand image, etc.)

[A business’ objectives do not remain the same forever. As market situations

change and as the business itself develops, its objectives will change to reflect its
current market and economic position. For example, a firm facing serious
economic recession could change its objective from profit maximization to short
term survival.]
Past Paper Questions (Paper 1)
[1 mark]
Question Answer Marks
1 D 1
2 A 1
3 A 1
4 C 1
5 D 1
6 B 1
7 D 1
8 C 1
9 C 1
10 A 1
11 B 1
12 D 1
13 A 1
14 D 1
15 A 1
16 D 1
17 B 1
18 A 1
19 B 1
20 B 1
21 D 1
22 D 1
23 B 1
24 D 1
Past Paper Questions (Paper 2)

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Question Answer Marks

1 A reasoned discussion which accurately examines both sides of the economic 8
argument, making use of economic information and clear and logical analysis to
evaluate economic issues and situations. One side of the argument may have
more depth than the other, but overall both sides of the argument are considered
and developed. There is thoughtful evaluation of economic concepts,
terminology, information and/or data appropriate to the question. The discussion
may also point out the possible uncertainties of alternative decisions and
outcomes

Why it might fall:

 The firm may experience economies of scale; total cost will rise by less
than total output (long run average cost may fall as output increases)
 The firm may experience buying/purchasing economies of scale; may be
offered a discount price when buying raw materials in bulk
 The firm may experience technical economies of scale; larger, more cost
efficient technological equipment may be purchased to produce a higher
output
 The firm may experience managerial economies of scale; specialist staff
may be employed when output is high
 The firm may experience financial economies of scale; as output
 increases, it may be able to borrow more cheaply/or sell its shares at a
lower price
 The firm may experience R & D economies of scale; the R & D
expenditure can be spread over a higher output
 The industry may also be growing in size; enabling advantage to be
taken of external economies of scale

2  fertilisers 2
 palm oil seeds
 casual labour

Guidance:
If more than two are given, consider the first two only. Accept ‘labour’,
‘workers’ or ‘wages’ for ‘casual labour’
3 The total income / money received (1) from a firm’s sales (1). 2
OR
Price (1) multiplied by quantity sold (1).
4  Profit maximisation (1) making as much profit as possible / increasing 4
the gap between revenue and cost / rewarding entrepreneurs (1)
 Growth / expansion (1) increasing the size of the firm by e.g. merging /
seeking to gain market power (1) to take advantage of economies of
scale (1)
 Survival (1) during difficult times such as recession / when a firm is first
established the aim may just be to stay in the market (1)
 Profit satisficing (1) achieving enough profit to keep shareholders’
happy while following other objectives (1)
 Social welfare (1) business organisations operating in the public sector
may e.g. be concerned about the environment / charging a low price to
help the poor (1)

5  Fixed costs are costs that do not alter with output (1) in the short run (1) 6
 Rent may increase (1) landlords may decide to charge more for factories
and offices (1)
 The amount charged for insurance may increase (1) insurance companies
may be seeking higher profits / their costs may have risen (1)
 Interest paid on loans may increase (1) e.g. the central bank may have
increased the rate of interest (1)
 A firm may have moved to a larger factory / changed its production
process / using more capital goods (1) leading to higher fixed capital
costs (1)
 Inflation may occur (1) increasing e.g. the cost of workers with long-
term contracts (1)