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Costs, revenue and profit

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Costs, revenue and profit

  1. 1. Fixed factors and variable factors• Variable factors are the inputs a manager can adjust to alter production in the short run, E.g, labour and materials• Fixed factors are the inputs that a manager cannot adjust to alter production in the short run. e.g., capital or land.
  2. 2. Short run and Long run
  3. 3. Short run and Long run
  4. 4. Total, Average and Marginal product
  5. 5. Total, Average and Marginal product
  6. 6. Total, Average and Marginal product
  7. 7. 1 2 3 4Quantity of Total product Average MarginalLabour (V) (TP) product (AP) product (MP)0 01 10 10 102 25 12.5 153 45 15 204 70 17.5 255 90 18 206 105 17.5 157 115 16.43 108 120 15 5
  8. 8. Total product curve
  9. 9. Average and marginal product curves
  10. 10. Production function Land Labour Out Production Process putCapital Enterprise
  11. 11. Short run and long run The short run is • The long run isdefined as that time that period of period where at time when all least one factor of inputs can beproduction is fixed. changed.
  12. 12. The Law of Diminishing Returns• The law of diminishing returns states that in all productive processes, adding more of one factor of production,(variable factor) while holding all others constant will at some point yield lower per-unit returns.
  13. 13. Theory explained• Consider a factory that employs laborers to produce its product. If all other factors of production remain constant, at some point each additional laborer will provide less output than the previous laborer. At this point, each additional employee provides less and less return. If new employees are constantly added, the plant will eventually become so crowded that additional workers actually decrease the efficiency of the other workers, decreasing the production of the factory. Read more: http://www.investopedia.com/terms/l/lawofdiminishingmarginalreturn.asp#ixzz292UDwHY4
  14. 14. Explicit Cost Implicit cost• The costs that have a • The cost of using the firm’s money value like raw own resources. This is the materials, energy, rent, earnings that a firm could interest and wages and have had if it had employed have to be purchased from its factors in another outside the use/hired/sold out.(Normal firm.(Accounting costs) profit)• (Accountant’s view) • (Economist’s view)
  15. 15. Short run costs Total costTFC TVC TC
  16. 16. • TFC is the total costs of the fixed assets.TFC • It is a constant amount. • TVC is the total costs of the variable assets.TVC • TVC increases as more variable factors are used. • Total costs of all fixed and variable factors.TC • TC=TFC+TVC
  17. 17. Using data given, draw TC,TVC and TFC CurvesLabour TFC TVC TC0 400 0 4001 400 200 6002 400 400 8003 400 600 10004 400 800 12005 400 1000 14006 400 1200 16007 400 1400 1800
  18. 18. Average costsAFC AVC ATC
  19. 19. • AFC is the fixed cost per unit of output.AFC • AFC=TFC divided by output • AVC is the variable cost per unit of output.AVC • AVC=TVC divided buy output. • ATC is the total cost per unit of output.ATC • ATC= TC divided by output.
  20. 20. Marginal Cost is the increase in thetotal cost of producing an extra unit ofoutput. MC= TC divided by output
  21. 21. AFC,AVC,ATC and MC Curves
  22. 22. The long run• Definition:• The long run is the planning stage.• Free to change all the factors of production.• But constrained by the current level of technology.
  23. 23. AttainableUnattainable
  24. 24. Increasing, Constant and Decreasing Returns• When long-run costs are falling, as output increases Increasing Returns.• When long-run costs are constant, as output increases Constant Returns.• When long-run costs are decreasing, as output increases Decreasing Returns.
  25. 25. • Economies of Scale:• The increase in efficiency of production as the number of goods being produced increases.• Diseconomies of Scale:• Rather than experiencing continued decreasing costs per increase in output, firms see an increase in marginal cost when output is increased.
  26. 26. 1. Specialisation:• As firms grows, they specialise in individual areas of expertise, production, finance, marketing….
  27. 27. ECONOMIES OF SCALE• 2. Division of labour:• As production increase, firms break-up the production process, and use division of labour and reduce the unit costs.
  28. 28. ECONOMIES OF SCALE• 3. Bulk buying:• Negotiate discounts with suppliers and reduce the unit costs.
  29. 29. ECONOMIES OF SCALE• 4. Financial economies:• Banks charge lower interest rate to larger firms because they are less risky and less likely to fail to repay.
  30. 30. ECONOMIES OF SCALE• 5. Transport economies:• Delivery cost is less. Can have own transport fleet.
  31. 31. ECONOMIES OF SCALE• 6. Large machines:• Big producer can own big machines and save the money spent on hiring machines oft and on.
  32. 32. ECONOMIES OF SCALE• 7. Promotional economies:• Advertising, sales promotion, personal selling, publicity…everything is possible for a big firm.
  33. 33. • TR when price does not change.(Horizontal demand curve)• The firm does not have to lower the price to sell more output.• If PED=perfectly elastic, then• P=AR=MR=D• TR curve is upward sloping.
  34. 34. • TR when price change as output increase.(downward sloping demand curve)• Firm has to lower price to sell more.• PED falls as output increases.
  35. 35. • TR rises at first but will eventually falls as output increases. When PED is elastic, to increase revenue, lower the price. When PED is inelastic, to increase revenue, raise the price. When PED is unity, to increase revenue, leave the price unchanged.
  36. 36. • Generally,• Profit =TR-TC.• But for an economist,• Profit= TR-Economic Cost(Explicit + Implicit Cost)
  37. 37. TR and TC Firm A Firm B Firm CTotal Revenue 200 000 200 000 200 000TFC 40 000 40 000 40 000TVC 80 000 100 000 120 000Implicit Cost 60 000 60 000 60 000Total Cost 180 000 200 000 220 000 Firm A: TR>TC Abnormal Profit Firm B: TR=TC Normal Profit Firm C: TR<TC Loss
  38. 38. Whether to produce or not? Firm A Firm B Firm CTR 80 000 120 000 150 000TFC(including opp.cost) 100 000 100 000 100 000TVC 100 000 120 000 140 000TC 200 000 220 000 240 000Loss 120 000 100 000 90 000 Firm A: Loss = FC+20 000 VC Firm B: Loss = FC Firm C: Loss = <FC
  39. 39. • At price P, firm is able to cover variable cost in the short run.• Shut down price is P1 =ATC P.• P=AVC P=AVC• Below this price, firm will shut down in the short-run.
  40. 40. P1 =ATC P=AVC
  41. 41. AR<ACAR=ACAR>AC

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