Economics • Firms and Production

Costs of Production

Total costs, revenue and profit

A cost diagram that updates as the sliders change. Output (batches of bread per week) Costs and revenue ($)

    Examples

    The bakery

    At this output

    Costs of Production — Explanation

    A firm's costs of production change as it makes more. The example is a bakery: it pays rent on its shop and ovens whatever it bakes, and pays for flour, power and staff hours for each batch it makes. Choose a view in the title bar.

    Total costs.

    Average costs (cost per unit).

    Economies of scale are what happens in the long run, when the firm can change its size. The long-run average cost curve (LRAC) falls while the firm gains economies of scale (bulk buying, better machines, cheaper loans…), reaches its lowest point at the minimum efficient scale (MES), then rises when diseconomies of scale set in (slow communication, poor coordination, unmotivated staff). Tap a region of the graph, or an economy in the list, to see it explained. External economies (the whole industry growing in an area) lower average cost at every size, so the whole LRAC shifts down.

    The sliders. Rent changes TFC (so TC, AFC and ATC, but not TVC or AVC). Input prices scale TVC (so TC, AVC and ATC). The price changes TR and profit, not costs. Output moves the point being read off the graph.

    Key formulae: TC = TFC + TVC; ATC = TC ÷ Q = AFC + AVC; AFC = TFC ÷ Q; AVC = TVC ÷ Q; TR = P × Q; profit = TR − TC = (P − ATC) × Q.

    Common exam mistakes: drawing TFC sloping, or TVC starting above zero; drawing ATC and AVC meeting (they get closer, but AFC is never zero); saying fixed costs never change (they don't change with output, but rent can still rise); confusing economies of scale (a long-run fall in average cost as the firm grows) with simply making more in the short run; mixing up total and average cost on the axis labels.

    Beyond IGCSE. Marginal cost (MC, the extra cost of one more unit) is not in the IGCSE syllabus. Tick the A Level extension switch in the Average costs view to show it: MC cuts AVC and ATC at their lowest points.

    Objective: Cambridge IGCSE Economics (0455) 3.7 and 3.8, firms' costs of production, revenue and profit, and economies and diseconomies of scale. Marginal cost is Cambridge International A Level Economics (9708).

    Where this fits

    • AP: AP Microeconomics
    • AQA: AQA A Level Business (7132); AQA A Level Economics (7136)
    • Cambridge: Cambridge IGCSE Business Studies (0450); Cambridge IGCSE Economics (0455); Cambridge A Level Business (9609); Cambridge AS Level Business (9609); Cambridge A Level Economics (9708)
    • IB: IB Business Management HL; IB Business Management SL; IB Economics HL
    • NCEA Level 1 Commerce: 92029 Demonstrate understanding of price determination for an organisation; 92029 Demonstrate understanding of price determination for an organisation; 92029 Demonstrate understanding of price determination for an organisation; 92031 Demonstrate understanding of the financial viability of an organisation; 92031 Demonstrate understanding of the financial viability of an organisation; 92031 Demonstrate understanding of the financial viability of an organisation
    • NCEA Level 3 Accounting: 91408 Demonstrate understanding of management accounting to inform decision-making
    • Pearson Edexcel International: Edexcel International GCSE Business (4BS1); Edexcel International GCSE Economics (4EC1); Edexcel International A Level Business; Edexcel International A Level Economics
    • USDP: USDP Business; USDP Economics

    Costs of Production — Key Terms

    Key concepts in English, with te reo Māori, Chinese (Simplified) and Korean.

    EnglishTe reo Māori中文（简体）한국어What it means on this page
    Fixed Costno attested term固定成本 (gùdìng chéngběn)고정비용 (gojeong biyong)A cost that does not change with the amount produced, such as rent, insurance or loan interest. It must be paid even at zero output, so total fixed cost (TFC) is a horizontal line.
    Variable Costno attested term可变成本 (kěbiàn chéngběn)가변비용 (gabyeon biyong)A cost that rises as output rises, such as raw materials, power and hourly wages. Total variable cost (TVC) is zero at zero output.
    Total Cost (TC)no attested term总成本 (zǒng chéngběn)총비용 (chong biyong)The whole cost of producing a given output: total fixed cost plus total variable cost (TC = TFC + TVC).
    Average Fixed Cost (AFC)no attested term平均固定成本 (píngjūn gùdìng chéngběn)평균고정비용 (pyeonggyun gojeong biyong)Fixed cost per unit of output: AFC = TFC ÷ Q. It falls continuously as output rises, because the fixed cost is spread over more units.
    Average Variable Cost (AVC)no attested term平均可变成本 (píngjūn kěbiàn chéngběn)평균가변비용 (pyeonggyun gabyeon biyong)Variable cost per unit of output: AVC = TVC ÷ Q. It is usually U-shaped.
    Average Total Cost (ATC)no attested term平均总成本 (píngjūn zǒng chéngběn)평균총비용 (pyeonggyun chong biyong)Total cost per unit of output: ATC = TC ÷ Q = AFC + AVC. Also called average cost (AC); it is usually U-shaped.
    Total Revenue (TR)no attested term总收益 (zǒng shōuyì)총수입 (chong suip)The money a firm receives from selling its output: price × quantity sold (TR = P × Q).
    Profitno attested term利润 (lìrùn)이윤 (iyun)Total revenue minus total cost (TR − TC). If it is negative, the firm makes a loss.
    Break-evenno attested term盈亏平衡 (yíngkuī pínghéng)손익분기 (sonik bungi)The output (or price) at which total revenue equals total cost (TR = TC), so the firm makes neither a profit nor a loss.
    Economies of Scaleno attested term规模经济 (guīmó jīngjì)규모의 경제 (gyumoui gyeongje)The fall in long-run average cost as a firm increases its scale of production, from advantages such as bulk buying, better technology and cheaper finance.
    Diseconomies of Scaleno attested term规模不经济 (guīmó bù jīngjì)규모의 불경제 (gyumoui bulgyeongje)The rise in long-run average cost when a firm grows too large, from problems such as poor communication, weak coordination and low staff morale.
    External Economies of Scaleno attested term外部规模经济 (wàibù guīmó jīngjì)외부 규모의 경제 (oebu gyumoui gyeongje)Falls in average cost that a firm gains from the growth of its whole industry, often in one area (a pool of skilled workers, specialist suppliers, better infrastructure). They shift the long-run average cost curve down.
    Long-run Average Cost (LRAC)no attested term长期平均成本 (chángqī píngjūn chéngběn)장기평균비용 (janggi pyeonggyun biyong)The lowest average cost of producing each output when the firm can change all its inputs, including its size. It falls with economies of scale and rises with diseconomies of scale.
    Minimum Efficient Scale (MES)no attested term最小有效规模 (zuìxiǎo yǒuxiào guīmó)최소효율규모 (choeso hyoyul gyumo)The scale at which long-run average cost is lowest: here, where the economies of scale end and the diseconomies begin.
    Marginal Cost (MC)no attested term边际成本 (biānjì chéngběn)한계비용 (hangye biyong)The extra cost of producing one more unit of output. It cuts AVC and ATC at their lowest points. (Cambridge A Level; not part of IGCSE.)

    On the te reo Māori column. Terms marked as gaps have no attested equivalent in the sources checked — Karaitiana Taiuru's Dictionary of Māori Computer and Social Media Terms, Paekupu, the Reserve Bank's te reo financial glossary, NZQA and Te Aka. No coinage is printed as though it were established; where a class needs one, commission it from Te Taura Whiri i te Reo Māori and credit the translator. Te reo Māori is not italicised and takes no plural "s".