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The Analysis of Costs, & Revenue: By: Gaurav Shreekant

This document discusses key concepts related to costs, revenues, and profits for businesses. It defines different types of costs like explicit costs, implicit costs, and opportunity costs. It also explains the differences between short run and long run costs and how average and marginal costs behave in each case. Revenue concepts like total revenue, average revenue and marginal revenue are introduced. Finally, the document discusses how profits are calculated and the different types of profits like normal profit and supernormal profit.

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Mayank Arora
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49 views

The Analysis of Costs, & Revenue: By: Gaurav Shreekant

This document discusses key concepts related to costs, revenues, and profits for businesses. It defines different types of costs like explicit costs, implicit costs, and opportunity costs. It also explains the differences between short run and long run costs and how average and marginal costs behave in each case. Revenue concepts like total revenue, average revenue and marginal revenue are introduced. Finally, the document discusses how profits are calculated and the different types of profits like normal profit and supernormal profit.

Uploaded by

Mayank Arora
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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The Analysis of costs, &

revenue

by: Gaurav Shreekant


- Money value of inputs is called cost of

production; &

- Money value of output is called revenue


Actual Costs: are those which are actually
incurred by the firm in payment for labour,
material, plant & machinery, travelling &
transport, etc. These are the costs that are
recorded in the books of accounts (accounting
costs).

Opportunity costs: It is the return expected


from the second best use of the resources,
which is foregone for availing gains from the
best use of the resources.
Explicit costs means the costs actually incurred by
making money payments to the input suppliers.
Purchases of materials, wages, rent, interest
payments, etc. i.e. all such expenses that are
recorded in books of accounts of the firm. Are also
called actual costs.

Implicit costs are the imputed (i.e. estimated) costs.


These include: -
a) The estimated value of inputs supplied by the
owner to his business for which he is not getting
paid; &
b) Normal profits
Economic costs is the sum of both explicit and
implicit costs including normal profit.

Economic Profit is calculated by deducting both


explicit and implicit costs from the value of
output (Total revenue).
Short run
• A period of time so short that the firm cannot alter
the quantity of some of its inputs (fixed factors –
say, land, plant & machinery etc.)
• Fixed inputs determine the scale of the firm’s
operation.
• Is also called the ‘actual production period’
during which certain inputs (say plant & machinery)
are fixed while other inputs are variable (material,
labour, etc.)
Long run is the ‘planning period’ during which
the firm takes decisions about changing the
scale, i.e. plant and equipment, or starting or
winding up the business.
S/R & L/R - not time periods but decision
periods; i.e. S/R decisions (production
decisions) and L/R decisions (planning
decisions).
A firm operates (actually produces) in S/R, and
plans in L/R.
Cost classification in short-run:
Fixed costs – costs that are not related
directly to production – rent, insurance
costs, administrative costs etc. These
change, not in relation to output, but in
relation to scale.
Variable Costs – costs directly related
to variations in output. Raw materials,
wages, etc.
Cost concepts in short-run
Short run fixed cost (SFC)
Short run variable cost (SVC)
Short run total cost (STC = SFC + SVC)
• Total Cost - the sum of all costs incurred in
production
TC = FC + VC
• Average Cost – the cost per unit
of output
AC = TC/Output
• Marginal Cost – the cost of one more unit of
production
MC = TC n – TCn-1
Behaviour of short run costs
Output Total Total Total AFC AVC ATC MC
Fixed Variable Cost
Cost Cost (TC)
(TFC)
(TVC)

0 60 0 60 - - - -
1 60 40 100 60 40 100 40
2 60 76 136 30 38 68 36
3 60 102 162 20 34 54 26
4 60 132 192 15 33 48 30
5 60 170 230 12 34 46 38
6 60 222 282 10 37 47 52
Short run Total costs
100 TC
TVC
80

60

40

20

TFC
0
0 1 2 3 4 5 6 7 8
Short run average costs
SATC

SAVC
Costs (£)

Output (Q)
Short run average & marginal costs
MC
ATC

AVC
Costs (£)

x
AFC

Output (Q)
Relationship between Marginal and Average
Costs
• As Output (Q) increases if
– MC<AC AC is falling
– MC>AC AC is rising
– So, when MC=AC, AC is at its minimum
• The above also applies to MC and AVC
Long Run Cost
• Changes to the scale of the plant
• Each plant size has a short run ATC curve
• Long run average cost curve is the lower
boundary of all short run ATC curves
• Long run and the least possible cost of
production
Average Total Cost in the Short and Long Run

Average
Total ATC in short ATC in short ATC in short
Cost run with run with run with
small factory medium factory large factory

$12,000

ATC in long run

0 1,200 Quantity of
Cars per Day
Average Total Cost in the Short and Long Run

Average
Total ATC in short ATC in short ATC in short
Cost run with run with run with
small factory medium factory large factory ATC in long run

$12,000

10,000

Economies Constant
of returns to
scale scale Diseconomies
of
scale

0 1,000 1,200 Quantity of


Cars per Day
Deriving a long-run average cost curve

LRAC
Costs

O
Output
Long-run average and marginal costs

LRMC
Initial economies of scale,
then diseconomies of scale
LRAC
Costs

O Output
Revenue
• Total revenue – the total amount received
from selling a given output
• TR = P x Q
• Average Revenue – the average amount
received from selling each unit
• AR = TR / Q
• Marginal revenue – the amount received
from selling one extra unit
of output
• MR = TR n – TR n-1 units
Profit
Profit = TR – TC
• The reward for enterprise
• Normal Profit – the minimum amount required to
keep a firm in its current line of production
• Supernormal profit – profit made over and above
normal profit
– supernormal profit may exist in situations where firms
have market power
– supernormal profits may indicate the existence of
welfare losses
– Could be taxed away without altering resource allocation
Profit
• Sub-normal Profit – profit below normal
profit
– Firms may not exit the market even if sub-
normal profits made if they are able to cover
variable costs
– Cost of exit may be high
– Sub-normal profit may be temporary (or
perceived as such!)
Break Even Analysis
TR
Costs/Revenue TC

Profit VC

Loss
FC

Q1 Output/Sales
Profit
• Assumption that firms aim to maximise
profit
• May not always hold true –
there are other objectives
• Profit maximising output would be where
MC = MR

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