[1.2.3a] Costs, revenues and profit

Costs, Revenues and Profit

Understanding a firm's financial performance requires mastery of six key concepts: total revenue, total costs, fixed costs, variable costs, average costs and profit. Each has a precise economic definition and a formula that the specification requires you to apply to numerical problems.

Revenue

Total revenue (TR) = Price (P) × Quantity sold (Q)

 Worked Example

Scenario: A bakery sells 400 loaves at £2.50 each.

  1. TR = £2.50 × 400 = £1,000 per day
If price rises to £3.00 but only 350 loaves sell: new TR = £3.00 × 350 = £1,050. Whether revenue rises or falls depends on PED.

Costs

Total fixed costs (TFC) do not change regardless of output — they must be paid even if output is zero.

TFC = constant (does not change with output)

Examples: factory rent, business insurance, loan repayments, management salaries.

 Example

A factory pays £5,000/month rent. Whether it produces 0 or 10,000 units, rent remains £5,000.

Total variable costs (TVC) rise as output increases; they fall to zero if output is zero.

TVC = Variable cost per unit × Quantity produced

Examples: raw materials, packaging, piece-rate wages, energy directly tied to production.

 Example

Ingredients cost £0.40 per loaf. TVC for 400 loaves = £0.40 × 400 = £160. For 800 loaves: £320.

TC = TFC + TVC

 Example

TFC = £5,000; TVC (400 loaves) = £160. TC = £5,000 + £160 = £5,160.

At 800 loaves: TC = £5,000 + £320 = £5,320. TC rises because TVC rises; TFC stays constant.

Average (total) cost (ATC) — cost per unit. Typically falls as output rises because fixed costs are spread over more units.

ATC = TC ÷ Quantity produced

 Example

  1. At 400 loaves: ATC = £5,160 ÷ 400 = £12.90 per loaf
  2. At 800 loaves: ATC = £5,320 ÷ 800 = £6.65 per loaf
Doubling output nearly halves ATC — fixed costs spread over more units. This is the essence of economies of scale.

Profit

Profit = Total revenue − Total costs

TR > TC = profit; TC > TR = loss; TR = TC = break even.

 Worked Example — Bringing It All Together

Scenario: A firm produces 500 units. Price = £20. TFC = £3,000. Variable cost per unit = £8.

  1. TR = £20 × 500 = £10,000
  2. TVC = £8 × 500 = £4,000
  3. TC = £3,000 + £4,000 = £7,000
  4. Profit = £10,000 − £7,000 = £3,000
  5. ATC = £7,000 ÷ 500 = £14 per unit
The firm makes £3,000 profit. Price (£20) exceeds ATC (£14), so each unit contributes £6 to profit.

 Key Takeaways

  • TR = P × Q
  • TFC — fixed, do not change with output.
  • TVC = variable cost per unit × Q — rise with output.
  • TC = TFC + TVC
  • ATC = TC ÷ Q — falls as output rises, spreading fixed costs.
  • Profit = TR − TC
a) Definition and use of formulae to calculate: • total revenue • total costs • total fixed costs • total variable costs • average (total) costs • profit.