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How do a firm's revenues, costs and profits behave as it changes output?

Total, average and marginal revenue and cost, the law of diminishing returns, economies and diseconomies of scale, and normal and supernormal profit.

An Edexcel A-Level Economics A answer to revenues, costs and profits, covering total, average and marginal revenue and cost, the law of diminishing marginal returns in the short run, internal and external economies and diseconomies of scale, and the difference between normal and supernormal profit.

Generated by Claude Opus 4.812 min answer

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  1. What this dot point is asking
  2. Revenue and cost concepts
  3. The short run: diminishing returns
  4. The long run: economies of scale
  5. Normal and supernormal profit
  6. Examples in context
  7. Try this

What this dot point is asking

Edexcel wants you to define and calculate total, average and marginal revenue and cost, explain the law of diminishing returns in the short run, distinguish economies from diseconomies of scale in the long run, and distinguish normal from supernormal profit.

Revenue and cost concepts

For a price-taker, AR and MR are equal and constant (a horizontal line). For a firm with market power, the demand (AR) curve slopes down, so MR lies below AR and falls faster.

The short run: diminishing returns

The long run: economies of scale

Normal and supernormal profit

Normal profit is the minimum return needed to keep a firm in the industry; it just covers opportunity cost and occurs where average cost equals average revenue (AC=ARAC = AR). Supernormal (abnormal) profit is any profit above normal, where average revenue exceeds average cost. A firm makes a loss where average cost exceeds average revenue, and shuts down in the short run only if price falls below average variable cost.

Examples in context

  • Car manufacturing. Huge technical economies of scale (robotic assembly lines) mean a high minimum efficient scale, favouring large firms.
  • Aldi and Lidl. Purchasing and operational economies let discounters undercut rivals, a real economies-of-scale advantage.
  • BP and Shell. Financial economies of scale: large firms borrow more cheaply, lowering long-run average cost.
  • Big-bank diseconomies. After mergers, some banks suffered communication and coordination diseconomies, raising unit costs and prompting later restructuring.

Try this

Q1. Explain the law of diminishing marginal returns. [3 marks]

  • Cue. Adding more variable factor to a fixed factor eventually reduces the marginal product, so marginal cost rises.

Q2. Distinguish between normal and supernormal profit. [3 marks]

  • Cue. Normal profit just covers opportunity cost (AC=ARAC = AR); supernormal profit is any profit above this (AR>ACAR > AC).

Exam-style practice questions

Practice questions written in the style of Pearson Edexcel exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

Edexcel 20185 marksA firm sells 200 units at £30\pounds 30 each. Total fixed cost is £2,000\pounds 2{,}000 and average variable cost is £18\pounds 18. Calculate total profit and state whether it is normal or supernormal.
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A worked calculation on revenue, cost and profit.

Total revenue =P×Q=£30×200=£6,000= P \times Q = \pounds 30 \times 200 = \pounds 6{,}000.

Total variable cost =AVC×Q=£18×200=£3,600= AVC \times Q = \pounds 18 \times 200 = \pounds 3{,}600; total cost =3,600+2,000=£5,600= 3{,}600 + 2{,}000 = \pounds 5{,}600.

Profit =TR−TC=6,000−5,600=£400= TR - TC = 6{,}000 - 5{,}600 = \pounds 400. Average cost is 5,600÷200=£28<£30=AR5{,}600 \div 200 = \pounds 28 < \pounds 30 = AR, so the firm earns supernormal profit (profit above normal, which is already included in costs).

Markers reward (1) TR and TC with working, (2) £400\pounds 400 profit, (3) identifying it as supernormal because AR>ACAR > AC.

Edexcel 202210 marksExamine the difference between the law of diminishing returns and diseconomies of scale, and their effects on a firm's costs.
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A 10 mark examine question (around 7 KAA, 3 evaluation).

KAA: explain that diminishing returns is a short-run effect (a variable factor added to a fixed factor lowers marginal product, raising marginal and average cost, giving the U-shaped SRAC), while diseconomies of scale is a long-run effect (all factors variable; coordination and communication problems raise long-run average cost beyond the minimum efficient scale).

Evaluation: the minimum efficient scale and the onset of diseconomies vary by industry; technology and good management can delay diseconomies. Reach a judgement.

Markers reward the short-run versus long-run distinction and a diagram.

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