Cost Revenue Analysis

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Costs and Revenue Analysis

• Cost is the most important consideration in production.


• A producer will not just jump into a particular investment simply
looking at the potential revenue of the business.
Economic Cost vs Accounting Cost
• Economic Cost – are forward looking costs, meaning, economists are
in tune with future costs because these costs have major effects on the
potential profitability of the firm.

• Accounting Costs – Tend to be retrospective; they recognize cost only


when these are made and properly recorded.

• Opportunity Cost - is the value that is forgone in choosing one


activity over the next best alternative.
Explicit Cost vs Implicit Cost
• Explicit Cost: Refers to the actual expenses of the firm in firm in
purchasing or hiring the inputs in needs, such as.
• When a firm purchases a machine worth one million rupees or rents a
building worth one hundred thousand rupees per month.

• Implicit Cost: Refer to the value of inputs being owned by the firm
and used in its own production process.
Business profit vs Economic Profit
• Business Profit: The difference between total revenue and explicit
cost.

• Economic Profit: The difference between total revenue and both


explicit and implicit costs.
Fixed Costs and Variable Costs
• Fixed costs are those costs, which do not vary with the changes in the
output of a product.
• They are associated with the existence of a firm’s plant and, therefore,
must be paid even if the firm’s level of output is zero.
• For example, a firm which has entered into a lease agreement for ten
years for hiring the office space has to pay the same rent whether the
level of output of the firm doubles or even becomes four times in that
ten year period.
Fixed Costs and Variable Costs
• Variable costs are those costs that vary with the level of output.
• They include payment for raw materials, charges for fuel and electricity,
payment of wages and salaries of temporary staff, and payment of sales
commission, etc.
• For example, in the case of hotel industry there is a high variation in
occupancy rates according to different seasons. A hotel on a hill station
may report 100 percent occupancy in summers while the situation changes
dramatically in winters when the occupancy rates are just 10-20 percent or
even lower.
• Hence, the industry hires lot of temporary staff during the period of high
occupancy, who are not retained during low occupancy periods.
• Average cost is the cost per unit.
• Marginal costs can be defined as the change in the total cost of a firm
as a result of change in one unit of output.
• These costs are important in short-term decision making of the firm to
determine the output at which profits can be maximized.

• Total cost (TC) is the cost associated with all of the inputs.
• It is the sum of TVC and TFC.
• TC=TFC+TVC
• Average Fixed Cost (AFC) – The total Fixed Costs divided by the number
of output produced (Q).
• AFC=TFC/Q

• Average Variable Cost (AVC) – The total Variable costs divided by the
number of output produced (Q).
• AVC = TVC/ Q

• Average Total Cost (ATC) – The total cost divided by the number of
output produced (Q). It is also defined as the cost per unit of output.
• ATC=TC/Q
• Marginal Cost (MC) – To Changes in total cost divided by the
change in output produced (Q). It is also the additional cost incurred
from producing additional unit of output.
• MC= ∆ TC/ ∆Q
Q TFC TVC TC AFC AVC ATC MC

0 30 0 30 - - - -

1 30 15 45 30 15 45 15

2 30 20 50 15 10 25 5

3 30 22.5 52.5 10 7.5 17.5 2.5

4 30 27.5 57.5 7.5 6.9 14.8 5

5 30 37.5 67.5 6 7.5 13.5 10

6 30 60 90 5 10 15 22.5
Revenue

• Wealth-maximizing
• Each seller has sufficient market power to set the selling price higher
and sell less OR set the selling price lower and sell more.
• The demand curve facing the price searcher is downward sloping
Total Revenue
• Total revenue ( TR ) is the total amount of money(or some other good)
that a firm receives from the sale of its goods.
• It is the firm practices single pricing rather than price discrimination,
TR = total expenditure of the consumer = P x Q
Average Revenue
• Average revenue ( AR ) is the total amount of money (or some other good)
that a firm receives from the sale divided by the number of units of goods
sold.
• AR = TR/Q, since TR=P x Q, then AR = P for single pricing practice.
Marginal Revenue
• Marginal revenue ( MR ) is the change in total revenue resulting from
selling an extra unit of goods.

• MR = TR/Q,
• where TR = change in TR due to change in Q,
• Q = change in Q

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