Production, Costs, Revenue and Market Structures
Domain 3 tests the cost–output link, and whether you can place a firm in the correct market structure and predict its output, price and efficiency.
Core rules
- Short run: at least one fixed factor. Long run: all factors variable.
- Law of diminishing returns: adding a variable input to a fixed factor eventually lowers marginal product, so marginal cost rises.
- TC = TFC + TVC; AC = TC ÷ Q; MC = ΔTC ÷ ΔQ. MC cuts AC at AC's minimum point.
- Economies of scale (technical, managerial, financial, marketing; external) lower long-run average cost; diseconomies raise it.
- For a price taker, P = AR = MR; for a firm facing downward-sloping demand, MR < AR.
- Profit is maximised where MC = MR and MC is rising. The shut-down point is P = minimum AVC.
- Perfect competition: many firms, homogeneous product, free entry → normal profit and allocative efficiency in the long run. Monopoly: barriers to entry, price maker, deadweight loss. Monopolistic competition: differentiated products, some market power, excess capacity in the long run. Oligopoly: interdependence, kinked demand curve, collusion or non-price competition.
Worked example
A firm maximises profit at Q = 200, where MC = MR = 10. Price is 18 and average cost 12. Profit = (18 − 12) × 200 = 1,200. Because average cost at that output exceeds minimum average cost, the firm is not productively efficient.
Traps
Saying a monopolist charges the highest possible price (it charges the profit-maximising price); treating normal profit as zero accounting profit when it is a cost inside AC; confusing economies of scale with diminishing returns.