Cambridge IGCSE and O Level Economics
Chapter 22: Firms’ costs, revenue
and objectives
Suggested answers to individual and group activities
Group activities
1 Fixed costs = rent, business rates, insurance, and depreciation.
Variable costs = flour, yeast, overtime pay and energy costs.
2 a Total revenue could rise and profits fall, if costs rise by more than total revenue.
b i
A fall in stock levels will reduce costs. Less staff time and less space will be required for
storage of products. These resources could then be put to alternative uses or the number
of workers employed and the building space used could be reduced.
ii A firm could seek to increase demand for its products by advertising. This might be on
television, in newspapers or through direct mailing. For instance, a successful advertising
campaign is one that increases revenue by more than the cost of the campaign.
Individual activities
1
Output
TC
TFC
TVC
AC
AFC
AVC
0
160
60
110
—
—
—
1
110
60
150
110
60
50
2
150
60
190
175
30
45
3
180
60
120
160
20
40
4
200
60
140
150
15
35
5
230
60
170
146
12
34
6
300
60
240
150
10
40
2 1
Output
Total profit ($)
10
−10
20
0
30
20
40
50
50
40
The profit maximising output is 40 units, since this is where profit is highest.
2
Output
Total cost ($)
10
100
20
150
30
180
40
240
50
340
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Cambridge IGCSE and O Level Economics
3 a Next’s total cost in 2016 was $4.1 bn − $0.821 bn = $3.279 bn.
b Next’s profit in 2015 was $4 bn − $3.2 bn = $0.8 bn.
c Good sites for a retailer are in city centres, where there are many potential buyers and hence
an increased potential revenue. Good window displays should attract more customers into
the shops and turn potential into actual revenue.
Suggested answers to multiple choice questions and
four-part question
Multiple choice questions
1 A
In the short run, insurance on buildings will not change with firm’s output, as the size of the
building will not alter. B, C and D are all variable costs.
2 D
The total cost is $500 ($200 + $300). Average total cost is total cost divided by output.
In this case,
3 C
$500
= $10.
50
Total revenue is price multiplied by quantity sold i.e. $4 × 100 = $400. Price is the equivalent of
average revenue, so in this case average revenue is $4.
4 A
Profit is maximised when profit is at its highest.
2
Four-part question
a A variable cost is a cost that changes when output changes. As output increases the cost of raw
materials, for example, would increase.
b A firm’s profit would increase if its revenue rose while its costs remained unchanged. For
example, an increase in income would be likely to increase demand for luxury handbags. This
would be likely to increase the revenue and profit received by the handbag producers.
A firm’s profit would also increase if its revenue remained unchanged while its costs fall. Its costs may
decline as a result, for instance, of a rise in labour productivity or a fall in the price of raw materials.
c A rise in output would have no effect on total fixed cost. This is because fixed costs are those
costs that are not directly related to output. They do not change as output changes in the short
run. For example, if a handbag producer makes more handbags, the cost of insuring its factory is
unlikely to alter. Figure 1 shows that total fixed cost remains unchanged as output increases.
Costs
Total fixed cost
0
Output
Figure 1
© Cambridge University Press 2018
Cambridge IGCSE and O Level Economics
In contrast, average fixed cost falls with output. This is because the unchanged total fixed cost
is spread over more units. The more output that is produced, the lower the average fixed cost of
production. Figure 2 shows how average fixed cost falls continuously with output.
Costs
AFC
0
Output
Figure 2
d It is usually assumed that firms in the private sector try to maximise profit. Profit is the reward to
entrepreneurs and provides the incentive to take the risk of making a loss. Profit also provides
the funds for further investment.
Firms in the public sector may follow a different objective. A state-owned enterprise (SOE) may
have a number of objectives. These are likely to be linked to social welfare. For example, a SOE
may try to reduce the external costs arising from pollution by investing in cleaner technology. It
may also seek to improve worker welfare by providing good working conditions.
Private sector firms may also try to improve working conditions. Firms have a number of
stakeholders, including shareholders, workers and consumers. A firm may try to satisfy the
interests of all these groups. At any one time, it may be focusing on one particular group but it
has to remember that it always has to keep its shareholders happy.
At certain times, a firm may not be able to think about making a profit. The economy may be
in recession with demand for most products falling. In this situation, a firm may put its efforts
into survival. It may, for instance, have to search for a favourable loan to cover any losses and for
lower-priced raw materials.
A firm may also, at least for a period of time, favour growth over profit maximisation. It may seek
to become larger to increase its market power and to raise the salary and status of its managers.
In the long run, all the objectives that private sector firms might pursue are likely to lead to profit
maximisation. Becoming larger may involve a firm eliminating competitors and gaining more
monopoly power. This may enable its ability to raise its price without losing many sales and
so may raise its revenue. Growing in size may also enable the firm to take greater advantage of
economies of scale and so lower its costs of production. Keeping all the stakeholders happy
may also increase profit. For instance, better working conditions and higher pay for workers
may increase labour productivity, which could lower costs of production and increase demand
because of higher quality. Achieving higher environmental standards may also increase demand
and firms that are seeking to survive are likely to want to maximise profit in the long run.
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