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How do costs, revenues and profit behave in the short and long run, and what are economies of scale?

1.4 Costs, revenues and profit: fixed and variable costs, marginal, average and total cost, the law of diminishing returns, economies and diseconomies of scale, total, average and marginal revenue, and normal and supernormal profit.

An OCR H460 answer to costs, revenues and profit, covering fixed and variable costs, marginal, average and total cost, the law of diminishing returns, internal and external economies and diseconomies of scale, the revenue concepts, and normal versus supernormal profit.

Generated by Claude Opus 4.812 min answer

Reviewed by: AI editorial process; not yet individually human-reviewed

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  1. What this dot point is asking
  2. Costs
  3. The law of diminishing returns
  4. Economies and diseconomies of scale
  5. Revenue
  6. Normal and supernormal profit
  7. Examples in context
  8. Try this

What this dot point is asking

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

Costs

Average fixed cost falls continuously as output rises (the same fixed cost is spread over more units), so even before scale effects, ATC falls at low output. The ATC curve is U-shaped because marginal cost first falls then rises.

The law of diminishing returns

Economies and diseconomies of scale

Internal economies (within the firm) include technical (specialised, indivisible machinery), purchasing (bulk-buying discounts), managerial (specialist managers), financial (cheaper borrowing), marketing and risk-bearing (diversification). External economies arise from the growth of the whole industry (a skilled local labour pool, shared infrastructure). Diseconomies arise from problems of control, coordination and communication and worker alienation as the firm becomes too big to manage.

Revenue

Normal and supernormal profit

Examples in context

  • Supermarkets. Giants such as Tesco exploit purchasing and distribution economies of scale that small grocers cannot match, lowering average cost.
  • Diseconomies in large organisations. Sprawling firms and bureaucracies can suffer coordination and communication problems that raise average cost, prompting restructuring.
  • Normal profit in competition. In the long run, free entry competes away supernormal profit in competitive markets, leaving only normal profit.

Try this

Q1. Distinguish between a fixed cost and a variable cost, with an example of each. [4 marks]

  • Cue. Fixed does not vary with output (rent); variable rises with output (materials).

Q2. Explain one internal economy of scale. [3 marks]

  • Cue. For example purchasing economies: bulk buying lowers the unit cost of inputs as the firm grows.

Exam-style practice questions

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

OCR H460/01 20194 marksA firm has total fixed costs of £90,000\pounds 90{,}000 and total variable costs of £150,000\pounds 150{,}000 when it produces 6,000 units. Calculate its average total cost and its average fixed cost at this output.
Show worked answer →

A short calculate question. Total cost is fixed plus variable: £90,000+£150,000=£240,000\pounds 90{,}000 + \pounds 150{,}000 = \pounds 240{,}000.

Average total cost is total cost divided by output: £240,000÷6,000=£40\pounds 240{,}000 \div 6{,}000 = \pounds 40 per unit. Average fixed cost is fixed cost divided by output: £90,000÷6,000=£15\pounds 90{,}000 \div 6{,}000 = \pounds 15 per unit.

Markers reward total cost, ATC (£40\pounds 40) and AFC (£15\pounds 15), each with units. Note AFC falls as output rises (spreading fixed costs), which is why ATC falls at low output even before economies of scale.

OCR H460/01 202112 marksAssess the view that large firms always have lower average costs than small firms.
Show worked answer →

A levels-of-response question. Knowledge and application: define economies of scale (falling long-run average cost as output rises) and give types (technical, purchasing, managerial, financial, marketing, risk-bearing). Larger firms can exploit these, lowering average cost, and draw the falling part of the long-run average cost curve.

Analysis: explain the minimum efficient scale and how it varies by industry.

Evaluation: beyond the minimum efficient scale, diseconomies of scale (control, coordination and communication problems, worker alienation) raise average cost, so very large firms can be less efficient. Some industries have a low minimum efficient scale, so small firms compete well. Conclude that size lowers cost only up to a point; the relationship depends on the industry's cost curve.

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