Firms, costs, revenue and market structure
Firms grow, combine and produce using different methods. Their costs and revenue determine profit, and the market structure they work in affects prices and choice.
📌 Key points
- Firms are in the private or public sector and in the primary, secondary or tertiary sector of the economy.
- Small firms survive by offering a personal service, serving niche markets and staying flexible; firms grow internally or by mergers.
- A horizontal merger joins firms at the same stage of production; a vertical merger joins firms at different stages; a conglomerate merger joins firms in unrelated industries.
- Economies of scale are falls in average cost as a firm grows (e.g. buying in bulk, better machines, cheaper finance); diseconomies of scale are rises in average cost (e.g. poor communication).
- Production can be labour-intensive or capital-intensive; productivity is output per worker (or per factor input) per period.
- Demand for factors of production is a derived demand: it depends on demand for the products they make.
- Total cost = fixed costs + variable costs; average total cost = total cost ÷ output. Fixed costs do not change with output.
- Total revenue = price × quantity sold; average revenue = total revenue ÷ quantity; profit = total revenue − total cost.
- Firms’ objectives include survival, growth, profit maximisation and social welfare.
- A competitive market has many firms and low barriers to entry, giving low prices and choice; a monopoly is a single supplier with high barriers to entry, which may charge higher prices.
📖 Key terms
- Productivity
- Output per worker (or per unit of input) in a given time.
- Horizontal merger
- A merger of firms at the same stage of production in the same industry.
- Vertical merger
- A merger of firms at different stages of production in the same industry.
- Economies of scale
- Falls in average cost that result from a firm increasing its scale of production.
- Fixed costs
- Costs that do not change with output in the short run, e.g. rent.
- Average total cost
- Total cost divided by output.
- Barriers to entry
- Things that make it difficult for new firms to enter a market.
- Monopoly
- A market with a single supplier.
✏️ Worked example
A firm has fixed costs of $2,000 and variable costs of $5 per unit. It makes and sells 400 units at $12 each. Calculate its average total cost and its profit.
- Variable costs = $5 × 400 = $2,000.
- Total cost = fixed + variable = $2,000 + $2,000 = $4,000.
- Average total cost = $4,000 ÷ 400 = $10 per unit.
- Total revenue = $12 × 400 = $4,800.
- Answer: ATC = $10; profit = $4,800 − $4,000 = $800.
Show your working and the formula in calculation questions; even if the final answer is wrong, working can earn marks. Always include the units ($ or units of output).
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