A-Level Economics Notes on Business Costs

Definitions

1. Total Cost (TC): The sum of all costs incurred by a business in the production of a certain level of output, including both fixed and variable costs.
2. Fixed Cost (FC): Costs that do not vary with the level of output produced. They are incurred even if the output is zero.
3. Variable Cost (VC): Costs that vary directly with the level of output produced. They increase as more is produced and decrease as less is produced.
4. Marginal Cost (MC): The additional cost of producing one more unit of output. It is calculated as the change in total cost that arises from an extra unit of production.
5. Average Total Cost (ATC): Total cost divided by the number of units produced. It is the sum of average fixed cost and average variable cost.
6. Average Fixed Cost (AFC): Fixed cost per unit of output, which decreases as production increases because the fixed cost is spread over more units.
7. Average Variable Cost (AVC): Variable cost per unit of output, which can vary with the level of production.
8. Sunk Cost: A cost that has already been incurred and cannot be recovered. Sunk costs should not affect future economic decisions.
9. Opportunity Cost: The cost of the next best alternative that is foregone when a decision is made. It represents the benefits that could have been received by taking a different decision.
10. Implicit Cost: The opportunity costs of using resources that the firm already owns. It represents the income the firm foregoes by using its own resources instead of renting, selling, or lending them.
11. Explicit Cost: A direct payment made to others in the process of running a business, such as wages, rent, and materials.
12. Economies of Scale: The cost advantages that a business can exploit by expanding the scale of production, leading to a decrease in average costs.
13. Diseconomies of Scale: The point at which a business grows so large that the costs per unit increase. It occurs due to factors such as increased complexity of management and communication inefficiencies.
14. Break-even Point: The level of production at which total revenues equal total costs, meaning that the business is making neither a profit nor a loss.
15. Short Run: The period during which at least one of a firm’s inputs is fixed. In the short run, businesses cannot adjust all costs, resulting in fixed and variable costs.
16. Long Run: A time period in which all inputs can be varied by the firm, and all costs are variable. There are no fixed costs in the long run.
17. Law of Diminishing Returns: A principle stating that if one factor of production is increased while others are held constant, the input of the variable factor will eventually yield progressively smaller increases in outputs.
18. Total Revenue (TR): The total income received by a firm from the sale of its products. It is the product of the price per unit and the number of units sold.
19. Profit: The financial gain achieved when the amount of revenue gained from a business activity exceeds the expenses, costs, and taxes needed to sustain the activity.
20. Marginal Revenue (MR): The additional revenue that one more unit of output brings to the firm. It is the change in total revenue that results from selling an additional unit of product.

Types of Business Costs

1. Total Costs (TC)

Total costs are the sum of all the expenses a business incurs in the production process. This includes both fixed and variable costs.

• Formula: TC = TFC + TVC

2. Fixed Costs (FC)

Fixed costs are expenses that do not change with the level of output produced. They are incurred even when production is zero.

• Examples: Rent, salaries, insurance, and loan payments.
• Characteristics: In the short run, fixed costs are constant and do not vary with output.

3. Variable Costs (VC)

Variable costs change with the level of output. They increase as production increases and decrease as production falls.

• Examples: Raw materials, direct labor costs, and utility bills related to production.
• Characteristics: Directly correlated with the level of production.

4. Marginal Costs (MC)

Marginal cost is the cost of producing one additional unit of output. It is an important concept for decision-making and pricing.

• Formula: MC = Change in TC / Change in Quantity (ΔTC/ΔQ)
• Characteristics: MC can decrease and then increase as output increases due to the law of diminishing returns.

5. Average Total Costs (ATC)

Average total costs are the total costs per unit of output, calculated by dividing total costs by the quantity of output produced.

• Formula: ATC = TC / Q or ATC = AFC + AVC
• Characteristics: ATC typically decreases, reaches a minimum point, and then increases as output increases.

6. Average Fixed Costs (AFC)

Average fixed costs are the fixed costs per unit of output, which decrease as the quantity of output increases.

• Formula: AFC = TFC / Q
• Characteristics: AFC diminishes as production increases, illustrating the spreading effect of fixed costs over a larger number of units.

7. Average Variable Costs (AVC)

Average variable costs are the variable costs per unit of output.

• Formula: AVC = TVC / Q
• Characteristics: AVC may initially decrease due to increasing returns to the variable factor but eventually increase because of diminishing returns.

Cost Behavior and Decision Making

• Short Run vs. Long Run: In the short run, some costs are fixed, while in the long run, all costs can be variable as firms can adjust all inputs.
• Economies of Scale: As firms increase production, they can lower their ATC by spreading fixed costs over more units and negotiating lower prices for bulk purchases.
• Diseconomies of Scale: Beyond a certain point, increasing production can lead to higher ATC due to factors such as management inefficiencies and higher wage demands from workers.