Costs, Revenue, Profit and Economies of Scale (A Level Economics)

Costs and revenue (A Level Economics) is the toolkit behind every market-structure diagram you will draw in Year 13. Seven cost terms, three revenue terms, one rule for profit. Get these right and perfect competition, monopoly and oligopoly are the same picture with different curves. This page gives you the formulas in one table, the short-run cost diagram and why MC cuts the average curves where it does, the long-run curve with economies and diseconomies of scale, revenue for a price taker and a price maker, the MC = MR rule, a worked example in pounds and three exam-style questions with the answers derived.

Spec map: where costs and revenue sit on your board

AQA’s section numbers are the PDF’s 4.1.x (the web version says 3.1.x); Edexcel’s are from Issue 2, OCR’s from v3.0 (June 2026) and Cambridge’s from the 2026-2028 syllabus, all checked in September 2026. The market structures that use these curves are on the perfect competition and monopoly page.

What you must be able to do

• Define and calculate TFC, TVC, TC, AFC, AVC, ATC and MC from a table.
• Explain the law of diminishing returns and why it makes MC and AVC rise.
• Draw the short-run cost curves with MC passing through the lowest points of AVC and ATC.
• Draw the long-run average cost curve, mark the minimum efficient scale, and explain economies and diseconomies of scale.
• Define and calculate TR, AR and MR, and draw them for a price taker and a price maker.
• Define normal profit, supernormal profit and a loss, find the profit-maximising output where MC = MR, and apply the shut-down rule.

The seven cost terms and their formulas

In the short run at least one factor is fixed, usually premises or machinery. Its cost is paid whatever the firm produces. Everything else is variable. Every cost curve in the exam comes from splitting cost into those two parts.

The short-run cost curves: why MC cuts AVC and ATC at their lowest points

Draw MC first, falling then rising. Then the two averages. One rule places everything: MC cuts AVC and ATC at their minimum points. Think of a batting average. If the next innings is below the average, the average falls. If it is above, the average rises. So the average is lowest exactly where the marginal equals it.

Three things to notice. The ATC minimum is to the right of the AVC minimum, because AFC is still falling and drags ATC down for a little longer. The gap between ATC and AVC is exactly AFC, so it shrinks as output rises. And AFC never reaches zero, it just keeps falling.

Long-run costs: economies of scale, the MES and diseconomies

In the long run every factor is variable. The firm can build a bigger plant, and the question changes from “how much should this kiosk repair” to “how big a business should this be”. The long-run average cost curve shows the lowest cost per unit at each output once the plant size is chosen to fit it.

The falling part is economies of scale: bigger output, lower cost per unit. The lowest point is the minimum efficient scale, the smallest output at which the economies run out: 6,000 units a week at £10 here. The rising part is diseconomies of scale. The dashed curves are the exam’s favourite twist. A plant built for 2,000 units is the cheapest way to make 2,000, but its own lowest cost, £15.33 at 3,333 units, is still above the £13.56 a plant built for 3,333 would manage. Each short-run curve touches LRAC once and sits above it everywhere else.

Revenue: AR, MR, and the price taker against the price maker

Revenue is what comes in. Total revenue is price times quantity. Average revenue is total revenue per unit, which is the price. Marginal revenue is the extra revenue from one more unit. The shape of the curves depends on one thing: does the firm have to cut its price to sell more?

Edexcel 3.3.1 pairs this with elasticity: on the falling part of AR, cutting the price raises TR only while demand is elastic. The elasticity page has the diagram.

Profit maximisation: the MC = MR rule

Profit is total revenue minus total cost. Normal profit is the minimum the owner needs to stay in the business, the return they could earn elsewhere. It is counted as a cost, so it sits inside ATC. Supernormal profit, also called abnormal profit, is anything above that. A loss is anything below it.

The rule is one line. Produce every unit whose marginal revenue is above its marginal cost, and stop where MC = MR. Before that point each unit adds more to revenue than to cost. After it, the reverse. Then read profit as (AR − ATC) × Q, the rectangle between price and average cost.

Worked example — a phone-repair kiosk

A kiosk in a shopping centre repairs phones. The rent is £120 a day whatever happens. Parts and labour are the variable cost. The going price for a repair is £75, and the kiosk cannot change it.

1. Fill in TC = £120 + TVC, then the three averages by dividing by Q, then MC as the change in TVC.
2. Diminishing returns set in after the third repair: MC falls to £30, then rises. AVC bottoms out at three repairs (£40) and ATC at five (£68), and MC crosses each just past its lowest point.
3. Revenue: the kiosk is a price taker, so AR = MR = £75 for every repair.
4. Apply the rule. The fifth repair costs £55, below £75, so do it. The sixth costs £80, above £75, so do not. Profit-maximising output is five repairs.
5. Profit = TR − TC = (5 × £75) − £340 = £375 − £340 = £35 a day of supernormal profit. Check either side: four repairs gives £15, six gives £30. Five is best.
6. The rent goes up by £30 a day. MC does not change, so the best output is still five repairs. Profit falls to £5. Fixed costs change the profit, never the profit-maximising output.

Every number here comes from the rent and the TVC column. Change the price to £60 and the MC column gives the new output in seconds.

Exam-style questions

Q1: Using the kiosk’s table, calculate average fixed cost, average variable cost and average total cost at four repairs a day. Explain why AFC falls as output rises. (4 marks)
A: AFC = £120 ÷ 4 = £30 (1). AVC = £165 ÷ 4 = £41.25 (1). ATC = £285 ÷ 4 = £71.25, which is AFC + AVC (1). AFC falls because the same £120 of rent is spread over more repairs (1).

Q2: The price of a repair falls to £50. Calculate the kiosk’s new profit-maximising output and its profit or loss, and explain whether it should keep trading in the short run. (6 marks)
A: At £50 the fourth repair (MC £45) is worth doing, the fifth (MC £55) is not, so output is four (2). TR = 4 × £50 = £200, TC = £285, a loss of £85 (1). Price £50 is above AVC £41.25, so each repair contributes £8.75 towards the rent, £35 in total (1). Closing would mean paying the £120 rent for nothing, a loss of £120, which is worse than a loss of £85 (1). Keep trading in the short run. In the long run, when the lease ends, £50 is below ATC and the kiosk should leave (1).

Q3: Examine two reasons why a firm’s average costs may rise as it grows. (8 marks)
A: A pair of explained points, each followed by where it stops being true.

• Reason 1, coordination: a bigger firm needs more layers of management, so decisions slow, messages get lost and mistakes multiply. On the diagram this is LRAC rising beyond the MES, 6,000 units in figure 2. Limit: flatter structures and better systems can push the MES out.
• Reason 2, motivation: in a large firm each worker is a small part of the whole, so effort falls and turnover rises. Limit: it depends on management and pay, and bites harder in firms that grow by merger.
• Evaluation line: both are diseconomies of scale. Whether they bite depends on the industry, because external economies from a growing industry can offset them for a while.

Examiner’s checklist: the mistakes that lose costs and revenue marks

• MC drawn through the average curves anywhere but their minimum. The crossing point is the whole point of the diagram.
• AFC drawn as a straight line or reaching zero. It falls at a slowing rate and never touches the axis.
• Economies of scale explained with fixed costs. That is the short-run fall in AFC. Economies of scale are about plant size and the long run.
• MR drawn on top of AR for a price maker. For a downward-sloping AR, MR is below it and twice as steep.
• “Profit is where MC = MR.” MC = MR gives the output. Profit is (AR − ATC) × Q at that output. Say both.
• Normal profit treated as zero profit. Normal profit is a cost. A firm earning it is doing fine, which is why it stays.

Key takeaways

• TC = TFC + TVC. ATC = AFC + AVC. MC is the change in TC from one more unit.
• Diminishing returns make MC rise, and MC cuts AVC and ATC at their lowest points.
• LRAC falls with economies of scale to the MES, then rises with diseconomies. Each short-run curve touches it once.
• A price taker has AR = MR, horizontal. A price maker has AR sloping down and MR below it, twice as steep.
• Profit is maximised where MC = MR. Read profit off the gap between AR and ATC.

FAQ

Q: Why does MC cut the average cost curve at its minimum?
A: Because of how averages work. While the marginal unit costs less than the average, adding it pulls the average down. Once it costs more, it pulls the average up. So the average stops falling exactly where marginal equals average. That holds for AVC and ATC both.

Q: Why is the average cost curve U-shaped?
A: In the short run AFC falls as output rises while AVC eventually rises with diminishing returns, so ATC falls and then rises. In the long run the U comes from economies of scale on the way down and diseconomies on the way up.

Q: What are economies of scale in A Level Economics?
A: Falls in long-run average cost as a firm grows. Internal economies come from inside the firm: technical, purchasing, managerial, financial, marketing, risk-bearing. External economies come from the industry growing around it. The minimum efficient scale is the output where they run out.

Q: What is the difference between normal profit and supernormal profit?
A: Normal profit is the return the owner needs to stay in the business, counted as a cost inside ATC. Supernormal profit is anything above it, the rectangle between price and ATC. It attracts new firms in, which is the story of the perfect competition page.

Q: How do I find the profit maximisation point on a diagram?
A: Where MC crosses MR from below. Drop a line to the axis for the output, go up to AR for the price and to ATC for the cost per unit. Profit is the gap between the two times the output. The A Level economics diagrams page shows it on both market-structure diagrams.

Q: How much calculation is there in costs and revenue questions?
A: A lot, on every board: completing a cost table, MC from TC, the profit-maximising output from a table, profit off a diagram. OCR writes “explain and calculate” against the whole section. Practise the kiosk table until it takes two minutes. The revision hub lists the other quantitative topics.

Turn the table into marks

If the cost table still takes ten minutes, or MC ends up cutting the average curves in the wrong place, one lesson fixes that. Which board, which year, which paper first? Answer those three and a lesson time follows within a day. The A Level economics tutor page lists the rate.