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    Analysis of Cost, Profit and Total Revenue

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    Herrah Joyce Salinas
    The document analyzes costs, profits, and total revenue. It discusses: 1. The differences between economic and accounting costs, and between implicit and explicit costs. 2. Short-run cost analysis including total fixed costs, total variable costs, average and marginal costs. 3. Long-run cost analysis including the long-run average cost curve and long-run marginal cost curve. 4. Profit analysis including the points of maximum profit where total revenue exceeds total costs.

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    Analysis of Cost, Profit and Total Revenue

    Uploaded by

    Herrah Joyce Salinas
    78 views21 pages
    The document analyzes costs, profits, and total revenue. It discusses: 1. The differences between economic and accounting costs, and between implicit and explicit costs. 2. Short-run cost analysis including total fixed costs, total variable costs, average and marginal costs. 3. Long-run cost analysis including the long-run average cost curve and long-run marginal cost curve. 4. Profit analysis including the points of maximum profit where total revenue exceeds total costs.

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    The document analyzes costs, profits, and total revenue. It discusses: 1. The differences between economic and accounting costs, and between implicit and explicit costs. 2. Short-run cost analysis including total fixed costs, total variable costs, average and marginal costs. 3. Long-run cost analysis including the long-run average cost curve and long-run marginal cost curve. 4. Profit analysis including the points of maximum profit where total revenue exceeds total costs.

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    © All Rights Reserved
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    Download as pptx, pdf, or txt
    78 views21 pages

    Analysis of Cost, Profit and Total Revenue

    Uploaded by

    Herrah Joyce Salinas
    The document analyzes costs, profits, and total revenue. It discusses: 1. The differences between economic and accounting costs, and between implicit and explicit costs. 2. Short-run cost analysis including total fixed costs, total variable costs, average and marginal costs. 3. Long-run cost analysis including the long-run average cost curve and long-run marginal cost curve. 4. Profit analysis including the points of maximum profit where total revenue exceeds total costs.

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    of 21

    ANALYSIS OF COST, PROFIT

    AND TOTAL REVENUE

    Presented by:
    Roy B. Gacus
    Accounting versus Economic Costs
    • Economic cost are forward looking cost, meaning,
    economists are in tune with future cost because
    these costs have major representation on the
    potential profitability of the firm. Economists are
    also giving emphasis on the so-called opportunity
    cost, or cost that are incurred by not putting the
    resources to optimum use.
    • If opportunity cost are measurable, it should be
    included in the decision making process, even
    though it is expensive to do so.
    Accounting versus Economic Costs
    • But there are some costs that should not be used in
    decision making such as sunk costs, because these are
    costs that are irretrievable due to the fact that these
    are already incurred and do not affect a firm’s decision.
    • Accounting costs tend to be reflective; they recognized
    costs only when these are made and properly
    recorded. They do not adjust these costs even if
    opportunity costs change. Therefore, the difference
    between economic costs and accounting costs is the
    opportunity cost.
    Implicit versus Explicit Costs
    • Explicit costs refer to the actual expenses of the firm in
    purchasing or hiring the inputs it needs.

    • Implicit costs refer to the value of inputs being owned by


    the firm and used in its own production process
    Short-run Cost Analysis
    • Short-run for a firm is a time horizon when one input is
    held constant.
    • To analyze the short-run costs, it is essential to fix the
    level of capital and study the changes in the quantity of
    labor hired.
    • The following are the types of short-run costs:
    1. Total fixed cost (TFC). These are the costs that do not
    vary with output. Examples of these costs are
    depreciation of buildings and machineries, salaries of
    top management, rent expenses on leased plant, and
    interest payments on borrowing capital.
    Short-run Cost Analysis
    •2.   Total variable costs (TVC). These are costs that vary
    with output. Examples of these costs are payment for
    raw materials, wages, tax payments, and operating
    expenses (electricity, fuel, and water).
    3. Total cost (TC). It is the sum of total fixed costs and
    total variable costs.

    4. Average fixed cost (AFC). This refers to the total fixed


    costs divided by the number of output produced (Q).
    Short-run Cost Analysis
    •5.  Average variable cost (AVC). This refers to the total variable
    cost divided by the number of output produced (Q).

    6. Average total cost (ATC). This refers to the total cost divided
    by the number of output produced (Q). It is also defined as
    the cost per unit of output.

    7. Marginal cost (MC). It refers 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.
    Short-run Cost Analysis
    • Example: Complete the table using the data below. Then, plot TFC, TVC,
    TC in the same axes, and AFC, AVC, ATC, and MC in the same axes.

    Q TFC TVC TC AFC AVC AC 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 6.875 14.375 5
    5 30 37.5 67.5 6 7.5 13.5 10
    6 30 60 90 5 10 15 22.5
    Long-run Cost Analysis
    • Long-run is a time period wherein all fixed factors
    can be varied.
    • The long-run average total cost (LAC) of producing
    a given level of output is always the lowest point of
    the short-run average total cost of producing that
    output.
    • The LAC is the curve tangent to each short-run
    average cost (SAC) representing different plant sizes
    that the firm can build in the long-run.
    Long-run Cost Analysis
    Suppose that four of the option scales of plants
    that the firm could construct in the long-run are
    Cost given by SAC1 , SAC2 , SAC3 and SAC4 in figure.

    A SAC4
    19 SAC1
    LAC
    15 B SAC3 D
    SAC2
    14 C
    11

    Quantity
    0 4 9 15 20
    Long-run Marginal Cost
    • The long-run marginal cost (LMC) measures
    the change in long-run total cost from a given
    change in output.
    • The LMC IS U-shaped and reaches its
    minimum point before the LAC curve reaches
    its minimum just like in the short-run analysis.
    Long-run Marginal Cost
    In figure, LMC is over
    Costs LAC at the increasing
    LMC portion of the LAC

    LAC

    0 Quantity
    Profit Analysis
    • Business Profit refers to the difference between
    total revenue and explicit cost.

    • Economic profit is the difference between total


    revenue and both explicit and implicit costs.
    Point of Maximum Profit
    • Profit(π)
      equals total revenue (TR) less total cost (TC).
    Whereas, total revenue is equal to price (P) multiplied by
    quantity (Q). In symbols:
    = TR – TC
    TR = P x Q
    • To maximize profits, the firm must find the equilibrium
    price and quantity that give the largest profit on the largest
    difference between TR and TC. The rule is simple:
    TR > TC = profit
    TR < TC = loss
    TR = TC = break even
    Point of Maximum Profit
    • To illustrate the concept, let us assume that the price of a
    good is P16.00. Solve TR and profit given the quantity (Q)
    each point. Then, graph the TC and TR.
    Points Quantity (Q) Total Cost (TC) Total Revenue (TR) Profit (π)
    A 0 1,600 0 -1,600
    B 100 4,000 1,600 -2,400
    C 200 4,600 3,200 -1,400
    D 300 4,800 4,800 0
    E 400 5,048 6,400 1,352
    F 500 5,550 8,000 2,450
    G 600 6,400 9,600 3,200
    H 700 8,000 11,200 3,200
    I 800 12,800 12,800 0
    The Profit of the Firm in the Short-run
    • A competitive firm takes the market price as
    constant. If it wants to maximize profits, the
    optimum level of production in the short-run is
    when its marginal cost is equal to its price (since in a
    competitive market, price is also equal to marginal
    revenue).
    Price is greater than average total
    cost (P > ATC)
    In figure, the optimum of
    MC the firm in the short-run is
    Price
    given by Q0, where P= MC.
    Profit We use ATC to find the total
    cost in order to compute for
    the profit. In this case the
    P = MR
    firm is earning profits
    ATC
    because price is greater
    AVC than the cost (ATC) given by
    the shaded region.
    Quantity
    Q0
    Optimum Output in the Short-run
    Price is equal to average total cost
    (P = ATC)

    MC The figure shows the


    Price case where a firm is
    either experiencing
    profits or losses. As
    ATC shown in the graph,
    P = MR price is equal to
    AVC marginal cost denoting
    the best level of output.
    But since price equals
    ATC, the firm is at a
    Quantity breakeven (TR = TC).
    Profit is zero at price
    Q0
    equal to ATC.
    Firm is neither experiencing Profit nor Loss
    Price is less than average total cost
    (P < ATC)
    Even if the price is below ATC, the
    MC firm may continue operating in
    Price the short-run as long as price is
    greater than AVC (P > AVC). In
    figure, price intersects marginal
    cost indicating the best level of
    ATC
    output, but is above the AVC
    P = MR curve which means that the firm
    should not shutdown even though
    AVC
    profits are negative. Why?
    Because TR > TVC, and shutdown
    the business will eliminate this
    extra revenue. The firm can still
    Quantity pay the wages, its operating
    expenses, and can still purchase
    Q0 some raw materials, but not
    Profits are negative but P > AVC (No shutdown) enough to cover the fixed cost.
    The Shutdown Point

    MC MC
    Price Price

    ATC ATC
    AVC AVC
    P P

    Qty Qty
    Q0 Q0
    P = AVC (Shutdown Point) Profits are negative and P < AVC (shutdown point)
    The Shutdown Point
    • The firm should shutdown if any of the following
    occurs, P = AVC or P < AVC. The left figure shows
    that price is equal to its marginal cost and average
    variable cost. It is no longer practical to continue to
    do business because revenue is just enough to
    cover the variable cost of the firm, and there is no
    excess revenue to cover fixed cost.
    • In the right figure, if P < AVC, the decision is to
    shutdown also, because total revenue is insufficient
    to pay variable costs.

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