What is the difference between fixed and variable costs?

Fixed costs are costs that do not change with the level of output in the short run, such as rent, insurance and loan repayments; a firm pays them even if it produces nothing. Variable costs change directly with output, such as raw materials, fuel and the wages of production workers; they rise as the firm makes more. Total cost is the sum of fixed and variable costs, and average (total) cost is total cost divided by the number of units produced. Knowing which costs are fixed and which are variable is essential for working out average cost and profit.

How is profit calculated, and what does it mean?

Profit is total revenue minus total cost. Total revenue is price multiplied by quantity sold, and total cost is fixed cost plus variable cost. If revenue exceeds cost, the firm makes a profit; if cost exceeds revenue, it makes a loss. Profit is the reward to enterprise for combining the factors of production and bearing risk, and it is the main signal that guides firms about what and how much to produce.

What are economies of scale?

Economies of scale are the falls in average (per-unit) cost that a firm enjoys as it grows larger and produces more output. The main types include technical economies (using larger, more efficient machinery), purchasing economies (bulk-buying discounts), managerial economies (specialist managers), financial economies (cheaper borrowing) and marketing economies (spreading advertising over more units). They explain why large firms can often undercut small rivals and why average cost falls as output rises, up to a point.

What are diseconomies of scale?

Diseconomies of scale are the rises in average cost that can occur when a firm grows too large. They arise mainly from the difficulty of managing a very large organisation: communication becomes slower and less accurate, coordination is harder, and workers may feel less motivated, all of which raise the cost per unit. Diseconomies explain why average cost eventually rises again after falling, giving the long-run average cost curve a U shape, and why there is often an efficient size beyond which growing further is counterproductive.

Why do small firms survive alongside large ones?

Small firms survive for several reasons even when large firms enjoy economies of scale. Some markets are small or local (a neighbourhood hawker stall or hairdresser), so there is no room for a giant firm. Some goods need personal service or customisation that large firms cannot easily provide. Some firms deliberately stay small to keep control or pursue non-profit goals. And small firms can be more flexible, filling niches the big players ignore. As a result, real economies contain firms of every size.

SingaporeEconomics

Firms, production and costs for Singapore O-Level Economics (2286): fixed, variable, total and average costs, revenue and profit, economies and diseconomies of scale, the goals firms pursue, and why firms come in different types and sizes

A module overview for Singapore O-Level Economics (SEAB 2286) on firms, production and costs: how fixed, variable, total and average costs combine with revenue to give profit, why average cost falls then rises with economies and diseconomies of scale, the goals firms pursue beyond profit, and why firms come in different types and sizes.

Generated by Claude Opus 4.88 min readSEAB-2286Updated 2026-06-13

Reviewed by: AI editorial process; not yet individually human-reviewed

Jump to a section

Why this module matters
Costs, revenue and profit
How size changes cost
What firms want, and how big they get
A worked cost and profit calculation
How this module is examined
Check your knowledge

Why this module matters

This module looks behind the supply curve at the firms that do the producing. Supply rises with price partly because a higher price covers a firm's costs, so understanding costs, revenue and profit makes the supply curve make sense. The module also explains why some firms grow huge while others stay tiny, through economies and diseconomies of scale, and why profit is not always a firm's only goal. These ideas feed directly into market structure, market failure (where large firms can gain market power) and the national economy, and the cost and profit calculations are reliable Paper 1 and Paper 2 material.

This overview ties together the dot points below, each with its own worked answer and practice. Begin with costs and profit, since the scale and goals topics build on them.

Costs, revenue and profit

The starting point is costs, revenue and profit. Every firm faces fixed costs (which do not change with output, such as rent) and variable costs (which rise with output, such as materials). Total cost is the sum of the two, and average cost is total cost divided by output. Revenue is price times quantity, and profit is total revenue minus total cost. These few definitions support a large share of the calculation questions in the course.

How size changes cost

Next, economies and diseconomies of scale explain why average cost usually falls as a firm grows (through technical, purchasing, managerial, financial and marketing economies), and why it can rise again if the firm grows too large and becomes hard to manage. This gives the long-run average cost curve its characteristic U shape and helps explain market structure.

What firms want, and how big they get

A firm's behaviour depends on its goals. Economists usually assume profit maximisation, but firms may also pursue survival, growth, market share or social aims, and these goals can conflict. Finally, types and sizes of firms explains why firms grow, how they grow, and why small firms survive alongside large ones, so that real economies contain firms of every size.

A worked cost and profit calculation

Working out average cost and profit

A bakery has fixed costs of $\text{S\textdollar}2\,000$ per month (rent and insurance). Variable costs are $\text{S\textdollar}3$ for each loaf (flour, energy and labour). In a month it produces and sells $1\,000$ loaves at a price of $\text{S\textdollar}8$ each.

step 1: calculate total variable cost

TVC = \text{S\textdollar}3 \times 1\,000 = \text{S\textdollar}3\,000

step 2: calculate total cost

TC = \text{fixed cost} + \text{total variable cost} = \text{S\textdollar}2\,000 + \text{S\textdollar}3\,000 = \text{S\textdollar}5\,000

step 3: calculate average (total) cost per loaf

AC = \frac{TC}{Q} = \frac{\text{S\textdollar}5\,000}{1\,000} = \text{S\textdollar}5 \text{ per loaf}

step 4: calculate total revenue and profit

TR = P \times Q = \text{S\textdollar}8 \times 1\,000 = \text{S\textdollar}8\,000

\text{Profit} = TR - TC = \text{S\textdollar}8\,000 - \text{S\textdollar}5\,000 = \text{S\textdollar}3\,000

The bakery makes $\text{S\textdollar}3\,000$ profit. Notice that if output doubled to $2\,000$ loaves, the $\text{S\textdollar}2\,000$ fixed cost would be spread over more units, lowering average fixed cost and so average total cost, which is a simple form of economy of scale.

How this module is examined

Calculate in the right order. Sort costs into fixed and variable, find total cost, then average cost, then profit from revenue minus cost.
Name the type of economy of scale. When explaining falling average cost, identify the specific economy (technical, purchasing, managerial, financial or marketing) rather than just saying costs fall.
Explain goals and survival in context. Use realistic examples, such as a hawker stall staying small for personal service, or a firm sacrificing short-run profit to grow market share.

Check your knowledge

Attempt these under timed conditions, then check the model solutions.

Distinguish between fixed costs and variable costs, with one example of each. (3 marks)
State the formulas for total cost, average cost and profit. (3 marks)
A firm has fixed costs of $\text{S\textdollar}500$ , variable costs of $\text{S\textdollar}4$ per unit, and sells 200 units at $\text{S\textdollar}8$ each. Calculate its profit. (3 marks)
Explain two economies of scale a large supermarket chain might enjoy. (4 marks)
Give two reasons why small firms continue to survive in a market dominated by large firms. (2 marks)

Solutions

Q1: Fixed costs do not change with the level of output in the short run; for example, rent must be paid even if nothing is produced. Variable costs change with output; for example, the cost of raw materials rises as more is produced.
Q2: Total cost = fixed cost + total variable cost. Average cost = total cost divided by quantity produced. Profit = total revenue minus total cost (where total revenue = price times quantity).
Q3: Total variable cost = $\text{S\textdollar}4 \times 200 = \text{S\textdollar}800$ . Total cost = $\text{S\textdollar}500 + \text{S\textdollar}800 = \text{S\textdollar}1\,300$ . Total revenue = $\text{S\textdollar}8 \times 200 = \text{S\textdollar}1\,600$ . Profit = $\text{S\textdollar}1\,600 - \text{S\textdollar}1\,300 = \text{S\textdollar}300$ .
Q4: Any two, explained: purchasing economies, since buying stock in huge quantities earns bulk discounts that lower the cost per unit; managerial economies, since the chain can employ specialist managers for buying, logistics and marketing whose cost is spread over many stores; financial economies, since a large firm can borrow more cheaply; or marketing economies, since advertising is spread over a very large volume of sales.
Q5: Any two of: they serve small or local markets where a giant firm has no advantage; they offer personal service or customisation that large firms cannot match; they are more flexible and can fill niches large firms ignore; or their owners choose to stay small to keep control or pursue other goals.

Sources & how we know this

Singapore-Cambridge GCE O-Level Economics (Syllabus 2286) — Singapore Examinations and Assessment Board (2026)