OxfordAQA International A Level Economics 3.3.2 Costs, Revenue and Profits Exam Questions

About OxfordAQA International A Level Economics 3.3.2 Costs, Revenue and Profits

Costs, revenue and profits gives the full theory of the firm used in Unit 3 of the OxfordAQA International A2 Economics course. It extends the AS introduction with the law of diminishing returns, returns to scale, the shapes of short-run and long-run cost curves and the link between marginal and average values. You also study marginal, average and total revenue, normal and supernormal profit, the profit-maximising rule and the effects of technological change. These diagrams are the building blocks for perfect competition, monopoly and oligopoly in 3.3.3. Examiners regularly ask you to calculate marginal values from a table and to explain the shape of cost curves.

What you need to know

• 3.3.2.1 Diminishing returns and returns to scale The law of diminishing marginal returns applies in the short run when a variable factor is added to a fixed factor: eventually marginal product falls. Returns to scale apply in the long run when all factors increase.
• 3.3.2.2 Short-run costs Average cost and marginal cost are U-shaped because of diminishing returns. MC cuts AC and AVC at their minimum points. Average fixed cost falls continuously as output rises.
• 3.3.2.3 Long-run costs The LRAC curve reflects economies and diseconomies of scale. Minimum efficient scale is the lowest output at which LRAC is minimised.
• 3.3.2.4 Revenue curves For a price taker, AR = MR = price. For a price maker, the AR curve slopes down and MR falls twice as fast with a linear AR. Total revenue is maximised where MR = 0.
• 3.3.2.5 Profit Profit is maximised where MC = MR. Normal profit is the minimum needed to keep the firm in the industry and is included in costs; supernormal profit is above this. A firm continues in the short run if price covers average variable cost.
• 3.3.2.6 Technological change New technology can lower costs, create new products and markets, and change market structure through creative destruction.

Common mistakes in 3.3.2 Costs, Revenue and Profits

• Explaining the U-shaped short-run AC curve by economies of scale. In the short run it is caused by diminishing returns; scale applies only in the long run.
• Drawing MC cutting AC at a point other than AC's minimum.
• Saying firms maximise profit where total revenue is greatest. Profit is maximised where MC = MR.
• Treating normal profit as zero profit in the accounting sense. It is a cost included in AC and represents the opportunity cost of staying in the industry.
• Calculating marginal cost as total cost divided by output. Marginal cost is the change in total cost from producing one more unit.

Try three 3.3.2 Costs, Revenue and Profits exam-style questions