A firm's costs come in two kinds. Fixed costs stay the same whatever it produces; variable costs rise with output.
Our example (made-up numbers)
| Meals a day | Total cost (TC) | Average cost (AC = TC ÷ Q) | Marginal cost (MC = change in TC) |
|---|---|---|---|
| 10 | €100 | €10.00 | – |
| 11 | €108 | €9.82 | €8 |
| 12 | €117 | €9.75 | €9 |
| 13 | €128 | €9.85 | €11 |
The points to remember
- AC = TC ÷ Q; MC = the change in TC from one more unit.
- When MC is below AC, AC falls; when MC is above AC, AC rises.
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Why does MC rise? The law of diminishing marginal returns: adding more workers to a fixed kitchen adds less and less output.
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Remember it as: MC cuts AVC and ATC at their lowest points.
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In the long run every input can change, so the firm can grow. Its cost per unit traces the long-run average cost curve.
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Why cost per unit changes as firms grow
Technical economies
Bigger machines do more work per euro.
Bulk buying
Large orders win lower prices per unit.
Specialisation
Experts do one job well.
Diseconomies
Too big to manage: slow decisions, poor communication.
Quick reminder
- Axes: Costs, revenue up the side, Q along the bottom, both labelled
- Curve: AC (or LRAC) sloping down across the whole range of output
- Not needed: MC, MR or AR
- No numbers, no title
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Paper 2 asked this in May 2022, for 4 marks. No diagram is needed.
Explain two economies of scale which may not be available to smaller farms.
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How the 4 marks are given
| Marks | What your answer needs |
|---|---|
| 3–4 | Two economies, each explained: how it lowers average cost |
| 1–2 | Two economies only stated |