Edexcel A-Level Economics A (9EC0) · Theme 3
Specification points
- Total, average and marginal revenue.
- Total, average and marginal cost; short-run and long-run costs.
- The law of diminishing returns and returns to scale; economies and diseconomies of scale.
- Normal and supernormal profit; the shutdown points.
Revenue
- Total revenue (TR) = price × quantity.
- Average revenue (AR) = TR ÷ Q = price.
- Marginal revenue (MR) = the change in TR from one more unit.
Costs
- Total cost (TC) = fixed + variable costs.
- Average total cost (ATC) = TC ÷ Q.
- Marginal cost (MC) = the change in TC from one more unit.
Short run and long run
- In the short run, at least one factor is fixed, so the law of diminishing returns applies: adding variable factors eventually raises MC.
- In the long run, all factors vary, giving returns to scale — the source of economies (falling long-run average cost) and diseconomies (rising LRAC) of scale.
Key definitions
| Term | Definition |
|---|---|
| Diminishing returns | In the short run, extra variable inputs eventually add less to output, raising MC. |
| Economies of scale | Falling long-run average cost as output rises. |
| Normal profit | The minimum reward needed to keep a firm in the industry (where AR = ATC). |
| Supernormal profit | Profit above normal (AR > ATC). |
Profit and shutdown
- Normal profit occurs where AR = ATC; supernormal profit where AR > ATC.
- Short-run shutdown: produce only if price covers average variable cost (AR ≥ AVC).
- Long-run shutdown: exit if price does not cover average total cost (AR < ATC).
Worked example
A firm's price (AR) is £8, its AVC is £6 and its ATC is £10. In the short run it keeps producing because price covers variable costs and contributes to fixed costs. In the long run, since price is below ATC, it makes a loss and should exit unless conditions improve.
Common exam mistakes
- Confusing diminishing returns (short-run, variable factor) with diseconomies of scale (long-run, all factors).
- Getting the shutdown rules the wrong way round.
- Confusing normal and supernormal profit.
Exam technique
Use cost/revenue diagrams to identify profit, and apply the correct shutdown rule for the time period. Distinguish short-run diminishing returns from long-run scale effects.
Quick revision
- Diminishing returns (short run) vs returns to scale (long run).
- Normal profit: AR = ATC; supernormal: AR > ATC.
- Short-run shutdown: AR < AVC; long-run exit: AR < ATC.