What this lesson teaches
I can explain profit as total revenue minus total cost and find the profit-maximising output where MR equals MC with MC rising.
Syllabus 9570, 2.2.1(a). Objectives of Firms: Firms aim to maximise profits; Profit as the difference between total revenue and total cost; Profit-maximising output occurs at the point when marginal revenue (MR) equals marginal cost (MC) and where MC is rising
I can explain a firm's cost and revenue concepts in the short run and the long run.
Syllabus 9570, 2.2.2(a). Cost and Revenue: Firms' cost and revenue concepts in the short run and long run
I can explain internal and external economies and diseconomies of scale and link them to long-run average cost.
Syllabus 9570, 2.2.2(b). Cost and Revenue: Internal and external economies and diseconomies of scale and their link to the long run average cost of production
Make a guess
A bakery's price is below its average cost, but above its average variable cost. Should it close today?
- No. A firm with loyal customers should stay open whatever its costs.
- Yes. A firm making a loss should close at once.
- No. Staying open covers part of its fixed costs.
Show the answer
No. Staying open covers part of its fixed costs.
Fixed costs must be paid even if it closes. Each sale covers its variable cost and adds something towards rent, so the loss is smaller open than closed.
A whole H2 case study: 30 marks, about 75 minutes in the exam. Answer every part, then compare with the suggested answers.
This is a complete H2 case study in exam format: six parts worth 30 marks. It follows a bakery chain as its costs rise, using costs, economies of scale, the shutdown rule and firms' choices. In the exam you have 2 hours 30 minutes for two case studies, so allow about 75 minutes for this one, including reading time.
The bakery chain, Breadly, and every number in Figure 1 and Table 1 are illustrative: invented for practice, not official data. The rise in electricity prices and the productivity grant in Extract 2 are real.
Allow about an hour. Read the data and all three extracts first. Write each answer before you open its suggested answer, and use the level descriptors below to mark the 8- and 10-mark parts.
The extracts
Extract 1: Breadly grows
Breadly began as one bakery in a housing estate. As it opened more outlets, it built a central kitchen where large ovens bake bread for every shop. It also began buying flour, butter and packaging in bulk at lower prices. A single advertising campaign now promotes all its outlets. But managers say that beyond about 40 outlets, problems appear. Deliveries take longer across the island, managers struggle to keep quality the same in every shop, and decisions take longer to reach staff. Written for these notes; Breadly is invented.
Extract 2: Costs climb
Electricity prices for Singapore households and businesses rose sharply in 2022, as world gas prices jumped. Bakeries, which run ovens and refrigerators all day, were hit hard. Flour and butter also cost more. The government offers grants, such as the Productivity Solutions Grant, that help small firms pay for equipment and software that save labour or energy. Written for these notes from public information.
Extract 3: Breadly's choice
By 2025, Breadly's price of $3.00 a loaf no longer covers its average cost. Its owners are considering three options. They could raise prices, which loyal customers may resent; buy automated ovens and packing machines with the help of a grant; or close some outlets. Rival bakeries and supermarket bread are never far away. Written for these notes; Breadly and its figures are invented.
How the 8- and 10-mark parts are marked
Data parts (1 to 2 marks)
Point-marked. A 'describe' part gives 1 mark for the overall pattern and 1 for a refinement. A 'calculate and explain' part gives marks for the working and for what the result shows.
8 marks: L2 (4 to 6)
Both sides are explained with clear cost and revenue reasoning and tied to evidence from the case. A top L2 answer develops both sides fully.
8 marks: L1 (1 to 3)
One-sided, or points listed without explanation, or little use of the case.
8 marks: E (1 to 2)
E2: a reasoned judgement in the context of the case that says what the answer depends on, such as the time frame. E1: a judgement that is stated but not explained.
10 marks: L2 (4 to 7)
Automation and at least one alternative are analysed with clear chains, their limits and case evidence. A one-sided answer is usually capped at about 5.
10 marks: L1 (1 to 3)
Mostly descriptive, one-sided, or not tied to the case.
10 marks: E (1 to 3)
E3: a well-reasoned judgement on the best option for Breadly, with a conclusion. It uses criteria such as the effect on costs and revenue, risk and the time it takes. E2: a reasoned judgement with less support. E1: an unsupported judgement.
| Number of outlets | 5 | 10 | 20 | 40 | 56 |
|---|---|---|---|---|---|
| Average cost per loaf ($) | 2.00 | 1.60 | 1.30 | 1.20 | 1.35 |
| 2023 | 2025 | |
|---|---|---|
| Price ($) | 3.00 | 3.00 |
| Average variable cost ($) | 1.80 | 2.40 |
| Average fixed cost ($) | 0.70 | 0.80 |
| Loaves sold per month | 500,000 | 480,000 |
Worked example: The shutdown rule
Suppose a cafe sells drinks at $5. Its average variable cost is $4 and its average fixed cost is $2, so its average cost is $6.
- Price ($5) is below average cost ($6), so the cafe makes a loss of $1 on each drink.
- But price is above average variable cost ($4), so each drink adds $1 towards fixed costs.
- Closing would leave all the fixed costs unpaid: a bigger loss. So it stays open in the short run.
- In the long run, if price stays below average cost, it should leave the industry.
Watch out for this
A firm making a loss should shut down at once.
In the short run, fixed costs must be paid even if the firm closes. If price covers average variable cost, staying open loses less than closing.
Check your understanding
Which of these is an internal economy of scale for a bakery chain?
- Buying flour in bulk more cheaply as the chain grows.
- Flour prices falling worldwide because of a good wheat harvest.
- A new MRT line near its shops brings in more customers.
Show the answer
Buying flour in bulk more cheaply as the chain grows.
Right. The chain's own growth lets it buy in bulk, lowering its average cost: an internal economy of scale.