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1.2.3 Business costs, revenues and profit

Syllabus
2026
Topic
1.2.3
Level
—

Learning objectives

1.2.3a Revenue, cost and profit formulaeDefine and use formulae to calculate total revenue, total costs, total fixed costs, total variable costs, average total costs and profit.1.2.3b Internal and external economies of scaleDefine economies of scale and internal economies of scale; explain purchasing, marketing, technical, financial, managerial and risk-bearing internal economies. Define external economies of scale and explain skilled labour, infrastructure, access to suppliers and clusters of similar businesses.1.2.3c Diseconomies of scale and the LRAC curveDefine diseconomies of scale and explain bureaucracy, communication problems, lack of control and distance between senior management and workers. Use an LRAC diagram to show internal economies, diseconomies and the output at which the business is most efficient.

Select and connect business cost, revenue and profit formulae

Total revenue=price×quantity sold\mathrm{Total\ revenue}=\mathrm{price}\times\mathrm{quantity\ sold}

Total costs=total fixed costs+total variable costs\mathrm{Total\ costs}=\mathrm{total\ fixed\ costs}+\mathrm{total\ variable\ costs}

Average total cost=total costsquantity producedProfit=total revenue−total costs\mathrm{Average\ total\ cost}=\frac{\mathrm{total\ costs}}{\mathrm{quantity\ produced}}\qquad \mathrm{Profit}=\mathrm{total\ revenue}-\mathrm{total\ costs}

Measure Meaning and calculation
total fixed costs (TFC) costs that do not vary with output in the period; TFC = TC − TVC
total variable costs (TVC) costs that vary with output; when a per-unit variable cost is given, TVC = variable cost per unit × quantity
total costs (TC) all fixed and variable costs together
average total cost (ATC) total cost per unit of output

At 2,000 units, TFC = 7,340andTVC=7,340 and TVC =4,760, so TC = 12,100andATC=12,100 and ATC =12,100 ÷ 2,000 = 6.05perunit.Ifrevenuewere6.05 per unit. If revenue were15,000, profit would be $2,900.

Keep totals and per-unit values distinct. Profit uses total revenue minus total costs; subtracting only variable cost overstates profit.

Separate internal and external economies of scale

Economies of scale are falls in long-run average cost as output and business scale increase. Internal economies arise from the firm's own expansion; external economies arise when growth of the surrounding industry lowers firms' costs.

Internal economy How expansion lowers average cost
purchasing bulk buying secures lower input prices
marketing campaign costs are spread over more units
technical specialised or high-capacity machinery raises efficiency
financial larger firms may obtain finance at lower rates or on better terms
managerial specialist managers improve decisions in particular functions
risk-bearing a wider range of products or markets spreads risk and stabilises use of resources
External economy Industry-level cost advantage
skilled labour a local pool of trained workers reduces recruitment and training difficulty
infrastructure improved transport, communications or utilities serve firms in the industry
suppliers nearby specialist suppliers reduce search, delivery or input costs
similar-business cluster shared knowledge and specialist services become easier to access

A firm's bulk-buying discount is internal because its own size creates it. A new specialist supplier serving every local firm is external because industry concentration creates the advantage.

Read economies, diseconomies and efficiency from LRAC

Diseconomies of scale occur when a firm's long-run average cost rises as it expands beyond an efficient scale.

Cause Why average cost can rise
bureaucracy extra procedures and approval layers slow decisions
communication problems information is delayed, distorted or fails to reach all units
lack of control managers find it harder to monitor quality, costs and worker performance
distance between senior management and workers leaders receive weaker operational feedback and workers feel less connected to decisions

On a U-shaped long-run average cost (LRAC) curve, the downward-sloping section shows internal economies of scale as output rises and average cost falls. The lowest point is the output at which the business is most efficient because LRAC is minimised. Beyond it, the upward-sloping section shows diseconomies of scale.

The most efficient output minimises average cost; it is not automatically the output with maximum total profit. Revenue and market demand also affect profit.