Microeconomic Decision‑Makers: Firms' Costs, Revenue and Objectives
What are the main costs a firm faces? 📊
Firms have Fixed Costs (FC) that stay the same no matter how much they produce, and Variable Costs (VC) that change with output.
Key cost formulas 💰
- Total Cost: \$TC = FC + VC\$
- Average Total Cost: \$ATC = \frac{TC}{Q}\$
- Average Fixed Cost: \$AFC = \frac{FC}{Q}\$
- Average Variable Cost: \$AVC = \frac{VC}{Q}\$
Example: The Bakery Analogy 🧁
Imagine a bakery that makes cupcakes.
- Rent of the shop: \$FC = £200\$ per month (doesn't change with cupcakes sold).
- Ingredients, electricity, and labour: \$VC\$ depends on how many cupcakes you bake.
- If you bake 100 cupcakes, and ingredients cost £1 each, then \$VC = 100 × £1 = £100\$.
- Total Cost: \$TC = £200 + £100 = £300\$.
- Average Total Cost per cupcake: \$ATC = \frac{£300}{100} = £3\$.
Cost table for different output levels 📈
| Output (Q) | Fixed Cost (FC) | Variable Cost (VC) | Total Cost (TC) | ATC | AFC | AVC |
|---|
| 50 | £200 | £50 | £250 | £5 | £4 | £1 |
| 100 | £200 | £100 | £300 | £3 | £2 | £1 |
| 150 | £200 | £150 | £350 | £2.33 | £1.33 | £1 |
Revenue and Profit 📈💵
Revenue is what the firm earns from selling its product.
- Price per unit: \$P\$
- Quantity sold: \$Q\$
- Total Revenue: \$TR = P × Q\$
- Profit: \$π = TR - TC\$
Exam Tip Box 📚
Tip: When calculating costs, always identify which costs are fixed and which are variable. Use the formulas above to double‑check your numbers. Remember that ATC = AFC + AVC – if you find one, you can find the other.
Quick Practice Problem 🧠
Suppose a firm has a fixed cost of £500 and a variable cost that is £2 per unit produced. If the firm sells 200 units at £10 each, calculate:
- Total Cost
- Average Total Cost
- Profit
Answer key: Total Cost = £900, ATC = £4.50, Profit = £1,000.
Key Takeaways 🎯
- Fixed costs stay constant; variable costs change with output.
- Use the cost formulas to analyse a firm's efficiency.
- Profit is the difference between total revenue and total cost.