To survive, a firm must earn more from selling than it spends producing. This chapter shows how economists split up costs, work out profit, and compare competition with monopoly.
Costs
Economists split a firm's costs into two kinds:
- Fixed costs do not change with output in the short run, for example rent and insurance. They must be paid even if nothing is produced.
- Variable costs change with output, for example raw materials and hourly wages.
Total cost = fixed costs + variable costs. Average cost = total cost ÷ number of units.
Revenue and profit
Revenue is the money earned from sales: price × quantity sold. Profit is what remains after costs: profit = total revenue − total cost. If revenue is below total cost, the firm makes a loss.
Economies of scale
As a firm grows, its average cost per unit often falls. This is called economies of scale. Reasons include buying materials in bulk more cheaply, using large specialised machines, and spreading fixed costs over more units. This is a major reason firms want to grow larger.
Competition versus monopoly
| Feature | Competitive market | Monopoly |
|---|---|---|
| Number of firms | Many | One dominant firm |
| Price | Kept low by rivals | Can be set higher |
| Choice | Wide | Limited |
In a competitive market, many firms compete, so prices tend to be lower and choice wider. In a monopoly, a single firm dominates and can charge a higher price because buyers have few alternatives, though large firms may still gain economies of scale.
Put these steps in order to calculate a firm's profit or loss:
- Add fixed costs and variable costs to find total cost
- Multiply price by quantity sold to find total revenue
- Subtract total cost from total revenue
- State whether the result is a profit or a loss