Costs, revenue, objectives of firms and market structure

Last time

Before we start: last time, in Choosing a job, wage differences and trade unions, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

What does it cost to produce?

A small bakery pays rent for its shop every month, whether it bakes ten loaves or a thousand. But it pays for flour only for the loaves it bakes. Those are two kinds of cost, and together with revenue they decide the firm's profit.

Fixed and variable costs

Fixed costs do not change with output in the short run: rent, insurance, and the salaries of managers. Variable costs change with output: raw materials, energy for machines, and the wages of workers paid per item. Total cost is fixed cost plus variable cost.

Average cost

Average total cost is total cost divided by output. The examiner found only the strongest answers could define it exactly. A bakery has fixed costs of 100 dollars a day, and a variable cost of 5 dollars a loaf. At 20 loaves, total cost is 100 plus 100, which is 200 dollars. Average total cost is 200 divided by 20, which is 10 dollars a loaf.

Why average cost falls

As the bakery makes more, the same 100 dollars of fixed cost is spread over more loaves, so average cost falls: 15 dollars at 10 loaves, 10 dollars at 20, and 7 dollars at 50.

Revenue and profit

Total revenue is price times quantity sold. Average revenue is total revenue divided by quantity, which is the price. If the bakery sells 20 loaves at 12 dollars, total revenue is 240 dollars. Profit is total revenue minus total cost: 240 minus 200, which is 40 dollars.

Objectives of firms

Profit maximisation: making the largest possible profit. The examiner noted this and growth were the most common answers. Growth: increasing size, sales or market share. Survival: just staying in business, which matters most for new firms or in a recession. Social welfare: some firms aim to protect the environment, treat workers well and help the community. Public sector firms aim to provide a service.

Competitive markets

A competitive market has many firms, selling similar products, with few barriers to new firms entering. Each firm must keep prices low and quality high, or customers switch to rivals. Consumers gain choice and low prices. But profits are low, so firms may have less money for research.

Monopoly

A monopoly is a market with a single supplier, or one firm so dominant that it controls the market. It has high barriers to entry, so new firms cannot join, and there are no close substitutes for its product. So it is a price maker: it can set a high price, because customers have nowhere else to go.

Barriers to entry

Legal barriers: patents, licences and government rights to be the only supplier. Cost barriers: the huge cost of setting up, and the big firm's economies of scale, which let it undercut any newcomer. Control of raw materials or of shops, and strong brand loyalty.

Competition and monopoly

Here are the two market structures compared on the points examiners ask about.

Is monopoly always bad?

Against: higher prices, less choice, and lower quality, because there is no pressure from rivals. It may also become inefficient. For: a monopoly may have large economies of scale, so its costs are low, and high profits can pay for research into new products. When firms close and a market becomes less competitive, consumers can be harmed through higher prices and less choice.

Mistakes that lose marks

Mistake one: defining average cost as the cost of all the output. It is total cost divided by output. Mistake two: listing fixed costs that change with output, such as raw materials. Mistake three: saying a monopoly always charges high prices, with no other side. The fix: exact formulas, correct examples, and both sides.

The full-marks tip

The full-marks tip: give the formula for every cost or revenue term, and show your working. For monopoly, give its features first, then the effects on consumers, both good and bad.

On one card

So, on one card: costs and market structure. Keep it for revision.