Test Your Knowledge Flash Cards 🔒Play Lemonaire 🔒Play Last Stand

Costs, Revenue and Profit » Costs, Revenue and Profit

What you'll learn this session

Study time: 30 minutes

Edexcel spec: 1.2.3 (a)

The difference between fixed costs and variable costs
How to work out total costs and average (total) costs
How to work out total revenue and profit
How to use a cost table to answer exam calculations

🔒 Unlock Full Course Content

Unlock This Course

Business costs: fixed and variable

The rent on this shop is a fixed cost, but the flour and butter rise with every extra cake: variable costs

Every business has to pay for things in order to produce goods or services. These payments are its costs. This lesson is examined on Paper 1 (Microeconomics and Business Economics), and calculations like these are very common there. Economists split costs into two groups, depending on what happens when the business changes how much it makes.

Key terms:

Total fixed costs (TFC): costs that do not change when output changes, such as rent, insurance and fixed salaries.
Total variable costs (TVC): costs that change directly with output, such as raw materials, packaging and the electricity used by machines.
Total costs (TC): all the costs of producing a given level of output, found by adding total fixed costs and total variable costs.
Average (total) costs (ATC): the cost of producing one unit, found by dividing total costs by the number of units produced.

🔒 Fixed costs

The cookie stall pays £400 a week for its pitch and insurance. It pays this if it bakes 0 boxes or 400 boxes. Fixed costs stay the same as output changes. On a graph of cost against output they would be a flat line.

🍪 Variable costs

Flour, butter and boxes cost £3 for every box baked. Bake no boxes and this cost is zero. Bake twice as many and it doubles. Variable costs rise as output rises.

The formulae

You need to know each of these and be able to rearrange them.

Formulae to learn

Total costs = total fixed costs + total variable costs
Total variable costs = total costs - total fixed costs
Total fixed costs = total costs - total variable costs
Average (total) costs = total costs / quantity produced
Total revenue = price x quantity sold
Profit = total revenue - total costs

Remember from PED and Total Revenue that total revenue is the money a firm receives from sales, found by price multiplied by quantity sold. Here we use it to find profit.

If total revenue is bigger than total costs, the business makes a profit. If total costs are bigger than total revenue, the answer is negative and the business makes a loss. If they are equal, the business just breaks even.

Reading a cost table

Profit is what's left from total revenue once total costs are paid

Exam questions often give a table. The cookie stall sells each box for £6. The table shows one week. All figures are made up for practice.

Boxes made and sold	TFC (£)	TVC (£)	TC (£)	ATC (£)	TR (£)	Profit (£)
0	400	0	400	-	0	-400
50	400	150	550	11	300	-250
100	400	300	700	7	600	-100
200	400	600	1,000	5	1,200	200
400	400	1,200	1,600	4	2,400	800

Notice three things. Fixed costs never move. At 0 boxes the stall still loses £400, because the fixed costs must be paid. And average cost falls as output rises. The stall starts to make a profit somewhere between 100 and 200 boxes.

Worked example 1

Use the table to find the figures at 200 boxes.

Total costs = 400 + 600 = £1,000.

Average costs = 1,000 / 200 = £5 per box.

Total revenue = £6 x 200 = £1,200.

Profit = 1,200 - 1,000 = £200.

Worked example 2

A bike repair shop has average costs of £8 when it mends 250 bikes. Its total fixed costs are £500. Find its total variable costs.

Total costs = average costs x quantity = 8 x 250 = £2,000.

Total variable costs = 2,000 - 500 = £1,500.

Worked example 3

A language school sells 300 courses at £30 each. Its total costs are £9,800. Does it make a profit?

Total revenue = 30 x 300 = £9,000.

Profit = 9,000 - 9,800 = -£800.

The school makes a loss of £800.

Common mistakes

Putting rent or insurance in variable costs. If it does not change with output, it is fixed.
Forgetting that fixed costs are still paid at zero output.
Dividing by the wrong thing. Average cost is total costs divided by quantity, not total variable costs divided by quantity.
Using revenue as profit. Profit is what is left after total costs are taken away.
Writing a loss as a positive number. Show it as a negative profit or say "a loss of £800".

Exam-style question

Willow Wood Toys makes wooden trains. It sells each train for £18. The figures are made up for practice.

Trains made and sold	Total fixed costs (£)	Total variable costs (£)
100	1,000	1,000
200	1,000	2,000
400	1,000	4,000

(a) Define total fixed costs. [2 marks]

(b) Calculate total costs when 200 trains are made. [2 marks]

(d) Calculate the profit when 400 trains are made and sold. [3 marks]

(e) Explain why Willow Wood Toys makes a loss when it sells 100 trains. [2 marks]

Model answer

(a) Total fixed costs are costs that do not change when output changes (1), such as rent or insurance (1).

(b) Total costs = 1,000 + 2,000 (1) = £3,000 (1).

(d) Total revenue = 18 x 400 = £7,200 (1). Total costs = £5,000 (1). Profit = 7,200 - 5,000 = £2,200 (1).

(e) Total revenue is 18 x 100 = £1,800, but total costs are 1,000 + 1,000 = £2,000 (1). Costs are bigger than revenue, so there is a loss of £200 (1).

Exam tip

In calculation questions, write the formula, then put the numbers in, then give the answer with the £ sign. If your final answer is wrong, you can still get marks for correct working.

Recap

Fixed costs do not change with output. Variable costs change with output.
Total costs = total fixed costs + total variable costs.
Average (total) costs = total costs / quantity.
Total revenue = price x quantity.
Profit = total revenue - total costs. A negative answer is a loss.

Test Your Knowledge