• Fixed costs don't change with output (rent, insurance, loan repayments). Variable costs change directly with output (raw materials, direct labour).
• Total cost (TC) = Fixed costs (FC) + Variable costs (VC) — and TC can never be zero, because fixed costs exist even at zero output.
• Average cost (AC) is the cost per unit: TC ÷ Q. It usually falls at first, then eventually rises.
• Total revenue (TR) is all the money coming in from sales: Price × Quantity. Average revenue (AR) is just the price per unit — it's the same number as the selling price.
• Profit = Total Revenue − Total Cost. If TR = TC, the firm breaks even. If TR < TC, it makes a loss.
• As firms grow, they can benefit from economies of scale — falling average costs — thanks to internal factors (bulk buying, specialist managers) or external factors (skilled local workforce, better infrastructure).
• Grow too much, though, and diseconomies of scale kick in — average costs start rising again because of things like poor communication and bureaucracy.
• The long-run average cost curve is a U-shape: falling (economies of scale) → flattening at the minimum efficient point → rising (diseconomies of scale).

Fixed Costs (FC)

Think of fixed costs as the bills a business has to pay just to keep the doors open — regardless of whether it sells one item or ten thousand. If a bakery makes 0 loaves of bread this month or 5,000 loaves, the rent on the shop is exactly the same. That's the defining feature: fixed costs don't move when output moves.

• Examples: building rent, management/office salaries, insurance premiums, bank loan repayments.
• They're only "fixed" in the short run — over a longer period a business could move to a smaller building or renegotiate a loan, but within the period we're analysing, they stay flat.

Variable Costs (VC)

Variable costs move in lockstep with output. Make more units, and these costs rise; make fewer, and they fall. If our bakery bakes more bread, it needs more flour, more yeast, and more hours from the bakers actually mixing dough — all of that is variable.

• Examples: raw materials, wages of workers directly involved in production (not managers).
• Total variable cost (TVC) is calculated as: variable cost per unit × quantity produced.

Total Costs (TC) & Average Cost (AC)

Total cost is simply everything added together — the flat fixed-cost "floor" plus however much variable cost has piled up at that level of output. This is why total cost can never be zero: even a business making nothing still has to pay its rent.

Average cost tells you the cost per unit — useful for comparing efficiency at different output levels or setting a sensible price.

Worked example — a firm has fixed costs of $200 and a variable cost of $60 per unit:

Notice how AC keeps falling as output rises — the fixed cost of $200 is being "spread" across more and more units, so each unit carries a smaller share of it. This is the seed of the economies-of-scale idea you'll meet later.

Total Revenue (TR) & Average Revenue (AR)

Total revenue is the grand total of money a firm brings in from selling its goods or services — nothing subtracted yet, no costs considered. It's just: how much money landed in the till.

Average revenue is the revenue earned per unit sold — and here's the neat trick: it's mathematically identical to the selling price. That's why economists call AR "the technical name for price." It only becomes genuinely useful as a separate idea when a firm sells multiple products at different prices (like a supermarket) or the same product at different prices to different customers (like a train company charging adults, children, and pensioners differently) — in those cases, AR gives you a single "average price" across everything sold.

Worked example — as price falls, more units get sold:

Profit, Breakeven, and Loss

Once you know TR and TC, profit is a one-step calculation. This is the moment where all the cost and revenue work pays off — literally.

• Profit occurs when TR > TC — revenue covers all costs and there's money left over.
• Breakeven occurs when TR = TC — the firm has earned exactly enough to cover its costs. No profit, but no loss either. This is a really important reference point in business planning.
• Loss occurs when TR < TC — the firm hasn't earned enough to cover what it spent.

Worked example — watch profit turn into a loss as output rises past a point:

The Big Picture: The U-Shaped Curve

Imagine a firm's long-run average cost (LRAC) plotted against how much it produces. It typically traces out a U-shape: average cost falls at first (economies of scale), reaches a lowest point (called productive efficiency or the minimum efficient point), and then starts rising again (diseconomies of scale) if the firm keeps growing past that point.

AVERAGE
 COST
  |\
  | \                              ___
  |  \                        ___/    \___
  |   \___                __/              (rising = diseconomies)
  |       \___________ __/
  |    (falling = economies)    ↑
  |                        MINIMUM EFFICIENT
  |                        POINT (lowest AC)
  +----------------------------------------------→ QUANTITY (Q)
    

Internal Economies of Scale

These happen because of growth inside the firm itself — nothing to do with the outside world.

External Economies of Scale

These come from changes outside the firm — in its local area or industry — as the whole industry (not just one firm) grows.

Internal Diseconomies of Scale

Grow too big, too fast, and problems generated inside the business start pushing average cost back up.