12

Costs, revenues and profits

Exam practice (pp. 13738)

1 Output (units) Fixed costs ($) Variable costs ($) Total costs ($) Average costs ($)
20 300 40 340 17.00
30 300 75 375 12.50
40 300 120 420 10.50
50 300 250 550 11.00

Hence, the output level with the lowest average cost of production is at 40 units
of output, where the average cost = $10.50
Award 1 mark for correct answer and 1 mark for showing the correct working out.
2 a) Fixed costs of production are those that do not change when the level of
output changes, e.g. Johnsons Candles may have rents of $4000 per month,
irrespective of how many candles it produces.
($3 2500) + $4000
b) = $4.60
2500
c) TC = FC + VC = $4000 + ($3 2500) = $11500 per month
d) Profit = [($6 $3) 3000] $4000 = $5000
3 a) Total costs increase by $30000 for each extra 1000 batteries produced. Hence,
AVC = 30000 1000 = $30 per battery
b) When there is no output, TFC = $20000
c) Output level (batteries) Total costs ($) Average costs ($)
1000 50000 50.00
2000 80000 40.00
3000 110000 36.67

AC falls from $50 per battery to just $36.67, i.e. the fixed costs of production
are spread over a greater number of units of output.
In the questions above, award 1 mark for the correct answer and 1 mark for
showing the correct calculation (working out).

Exam practice (pp. 13940)

1 Units sold
(pizzas per Sales Total fixed Total variable Total Profit/
week) revenue ($) costs ($) costs ($) costs ($) Loss ($)
0 0 4000 0 4000 4000
400 6000 4000 4000 8000 2000
800 12000 4000 8000 12000 0
1200 18000 4000 12000 16000 + 2000

Deduct 1 mark for each incorrect calculation, but apply the error carried forward
rule.

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 12 Costs, revenues and profits

2 a) Advertising costs do not change with the level of output at Mintjens Curtains
Ltd. Hence, advertising costs are an example of fixed costs for the company.
b) Fixed costs = advertising + rent + salaries = $6700
c) TVC = $15 300 = $4500
TFC = $6700
Hence, TC = $11200
d) TR = $50 300 = $15000
Hence, profit = $15000 $11200 = $3800
3 a)
Output (units) 20 30 40 50
Total costs ($) 120 150 190 230
Total revenue ($) 100 150 200 250

Award 1 mark for each correct calculation, up to 4 marks.

b) Hence, the firm should produce 50 units to maximise its profits.
Output (units) 20 30 40 50
Total costs ($) 120 150 190 230
Total revenue ($) 100 150 200 250
Profit ($) 20 0 10 20

4 a) Revenue refers to the money a firm receives from selling its products. For
example, airlines get their revenue from selling airline travel services.
b) Arguments in favour of the merger (lower costs and higher profits) include:
l There are huge economies of scale for the larger airline, given its 6700 daily
flights. This helps to reduce costs whilst earning more sales revenue.
l Monopoly power is gained as the merger allows the two firms to become
the largest airline in the world.
l External growth allows the merged airline to be in a stronger position to
compete with other large US and foreign airline companies. This helps to
ensure the profitability and survival of the company in the long run.
l A stronger brand, or greater brand presence, can also help to improve the
merged airlines profits in the long run.
Counter arguments include:
l Mass redundancies, which often occur with large mergers, can lead to
higher redundancy payments in the short run. This increases the airlines
costs. The negative image of a firm laying off workers can have damaging
impacts on a firms profits in the long run.
l Less competition can mean fewer incentives to be competitive, so this can
ultimately lead to lower profits for the merged airline company.
l By becoming too large, the airline could experience diseconomies of scale, thus
face higher unit costs of production. The company might struggle to oversee
the 6700 flights each day due to communication problems, for example.
l With higher profits, workers for the merged airline are likely to
demand higher rates of pay and this can increase the airlines costs
disproportionately.
Accept any other advantages or disadvantages that are clearly explained and
written in the context of the airline industry.
Award up to 4 marks for a one-sided argument.
Award 56 marks for a thorough discussion of the merits and drawbacks of the
merger.

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 12 Costs, revenues and profits

For 78 marks, there must be a justified argument about whether the merger
would be likely to lead to lower costs and higher profits for the newly formed
airline.

Activity (p. 141)

Students own answers. Objectives of private sector firms are likely to include:
profit maximisation, increased market share, higher sales revenue, corporate social
responsibilities, increased productivity and improved competitiveness. Co-operatives
will have different objectives, as will not-for-profit organisations, such as charities.

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