Costs, Revenues & Profit (Edexcel IGCSE Economics)

Different Types of Costs

Spec point — 1.2.3a

• In preparing goods/services for sale, firms incur a range of costs. These costs can be be broken into different categories

Fixed costs (FC)

• These are costs that do not change as the level of output changes

  • These have to be paid whether output is zero or 5000

    • E.g. Building rent, management salaries, insurance, bank loan repayments

Variable costs (VC)

• These are costs that vary directly with output

  • These increase as output increases and vice versa

    • E.g. Raw material costs, wages of workers directly involved in production

Total costs (TC)

• These are the sum of the fixed + total variable costs

Cost calculations and cost graphs

• Based on the above definitions, we can calculate several different types of costs

1. $\mathrm{Total} \mathrm{costs}(\mathrm{TC})=\mathrm{total} \mathrm{fixed} \mathrm{costs}(\mathrm{TFC})+\mathrm{total} \mathrm{variable} \mathrm{costs}(\mathrm{TVC})$

2. $\mathrm{Total} \mathrm{variable} \mathrm{cost}(\mathrm{TVC})=\mathrm{variable} \mathrm{cost}(\mathrm{VC})\times\mathrm{quantity}(Q)$

3. $\mathrm{Average} \mathrm{total} \mathrm{cost}(\mathrm{AC})=\frac{\mathrm{total} \mathrm{cost}(\mathrm{TC})}{\mathrm{quantity}(Q)}$

Exam Hint In your exams, the word total is often left out of the formula for average total cost. This means that AC and ATC have the same meaning

Example calculations using a variable cost of $60 per unit

Worked Example A firm manufactures books and has the following total monthly costs:

Type of cost	Cost
Raw materials	$4000
Rent	$1000
Loan repayments	$1200
Electricity (depends on output)	$900

Calculate total variable costs per month (2 marks)

Step 1: Calculate the variable costs

Variable costs = Raw materials + electricity

= $4000 + $900 (1)

= $4900 (1)

When calculating variable costs, only include costs that vary / change as output changes.

A Graphical Representation of Costs

Spec point — 1.2.3a

Types of Costs

Revenue

Spec point — 1.1.4g

• Total revenue is the total value of all sales a firm generates

$\mathrm{Total} \mathrm{revenue}(\mathrm{TR})=\mathrm{selling} \mathrm{price}(P)\times\mathrm{quantity} \mathrm{sold}(Q)$

• Average revenue is the overall revenue per unit. Average revenue is the technical economic name for "price"

$\mathrm{Average} \mathrm{revenue}(\mathrm{AR})=\frac{\mathrm{TR}}{Q}$

Revenue Calculation Example

• Average revenue information is especially useful to a firm selling multiple products (e.g. supermarkets) or a firm that sells the same item at different prices (e.g. rail tickets are usually priced differently for different types of commuters such as pensioners or children)
• The value in the AR column is identical to the value in the P column

Profit

Spec point — 1.1.2c

• Profit = total revenue (TR) - total costs (TC)

• Breakeven occurs when TR = TC This is the point at which the firm has generated enough revenue to cover all of its costs

  • No loss is made, but no profit is generated yet either

• Profit occurs when TR > TC

• A loss occurs when TR < TC

Profit Calculation Example

Worked Example A business sells 50 pairs of shoes. Variable costs are $5 per pair of shoes and fixed costs are $100. Customers pay $100. Which one of the following equals $5000? (1)

• A. Average Revenue
• B. Total Costs
• C. Profit
• D. Total Revenue

The correct answer is:D. Total revenue

TR = Price x Quantity

TR = $100 X 50 = $ 5000

Explanation:

A. Average Revenue is not correct because TR/Q = $500/50 = $100

B. Total Costs is not correct because TC = TFC + TVC = 100 + (5X50) = $350

C. Profit is not correct because TR - TC = $5000 - $350 = $4650