this ppt is about cost, revenue and profit of the firm.

1. COSTS, REVENUESAND PROFITS
Dr. Arifa Saeed

2. Cost
• Costs are all expenses and payments in the production process. Example: paying salaries, payments rent, paying
taxes etc. Costs can be categorized in FOUR ways:
1. Fixed Costs
2. Variables Costs
3. Total Costs
4. Average Costs
5. Average Fixed Cost

3. Fixed Costs
(FC)
• It is the part of total cost
which does not vary with
the output and will incur
even at zero output level.
Example: Rent, interest on
loan, Staff salary, license
fees etc.
• As we see from the diagram
above, graphically fixed
cost curve is horizontal or
parallel to the x- axis

4. Variable Cost
• It is the part of total cost which does
varies with the output and fall to zero
when output is zero. Example: Cost of
raw material, wages, and transportation.
• As we see from the diagram above,
graphically the variable cost curve:
1. Always originate frim zero
2. Is upward sloping and
3. Is parallel to the total cost curve

5. Total cost
• It is the sum of all
fixed and variable
costs on the
production process.
• Total Cost = Fixed
Cost + Variable Cost

6. Average Cost
• It is the total cost per unit of
output. In other words, it is the
cost of making one product.
When the firm experiences
“economies of scale” the
average cost decrease and
when the firm experiences
“diseconomies of scale” the
average cost increase.
• Average Cost = Total Cost
• Total Output

7. Average Cost
• Example:
• TC = $5000
• Q = 100
• AC = 5000/100 = $5/unit
• As we see from the diagram above, graphically the AC curve falls with the rise in output (From point a to b). At b
the average cost it is minimum and after b the AC rises with the increase in output. The reason for this is that with
an increase in production average fixed cost decreases continuously however average variable decreases till a
certain point after which it starts to increase.

8. Average Fixed Cost
• It is the total cost divided by
output. As the output increases
the cost decreases
• AFC = --------
FixedOutput_________
• Total Output

9. Function of cost
1. Helps in profit and Loss Calculation
2. Helps managers in taking decisions
3. Helps in calculating total cost
4. Nature of the cost can help in planning

10. REVENUES
• It is the money that a business receives from the sale
of goods and services It is also known as sales
revenue, sales turnover or Total Revenue.
• Sales Revenue = Price x Quantity Sold
• Example:
• Selling price per unit = $2
• Unit Sold = 1000
• Sales Revenue / Total Revenue / $2000

11. REVENUE
• As we see from the diagram above,
graphically the Total Revenue curve:
1. Originates from zero and is upward
slopping
2. TR should not be confused with
Variable Cost curve. Both of them
have same shape however VC is
parallel to TC whereas TR cuts
TC.

12. • It is the total revenue per unit output sold. In other words, it is the revenue earned
from sale of one unit. This is also known as the average price of a good.
• Average Revenue = ________Total Revenue_________
• Total Output
• Example:
• Total Revenue = $10,000
• Unit Sold = 1000
• Average Revenue = 10,000 / 1000 = $10

13. PROFITAND BREAK-EVEN
1. Profit
• Definition: It is a point where TR becomes equal to TC. A break-even chart gives the
graphical representation of profit. Beyond the break-even point the company makes a
profit, below the break-even company makes a loss. On the break-even no profit, no
loss.
•
• Profit = Total Revenue – Total Costs

14. PROFIT AND
BREAK-EVEN
1. Break Even
• Definition: It is a point where TR
becomes equal to TC. A break-even
chart gives the graphical
representation of profit and losses and
should always be nake in the exam to
illustrate the concept of profit. Beyond
the break-even point the company
makes a profit, below the break-even
company makes a loss. On the break-
even no profit, no loss.

15. PROFIT AND
BREAK-EVEN
• As we see from the above diagram all
points ahead of “1000” will generate a profit
since TR>TC. However, any point behind
“1000” will generate a loss, The area of
profit is shown by the shaded region after
point “1000” and the area of loss is the
shaded region behind point “1000”
• Profit = TR>TC
• Loss = TR<TC
• Break-Even = TR = TC

16. BUSINESS OBJECTIVES
•Corporate objectives are those that relate to the
business as a whole.
•They are usually set by the Top management of the
business and they provide the focus for setting
more detailed objectives for the main functional
activities of the business.

17. Objective Description
1. Profit Maximization This is when business try to maximize the different between its cost and
revenues. They help the business grow and persuade business owners
to take risks. It can also be regarded as the point where Marginal Cost =
Marginal Revenue.
1. Growth This aims to maximize sales and value of output. This helps the firm
earn economics of scale, these firms enjoy greater control over the
market and motivates managers to work hard.
1. Increase Market Share This is the ration between the sales of the company and the sales
industry. Higher the market share, the larger the business.
Market Share % = Company Sales x 100
Total Market Share
1. Survival This is usually an objective for newly established business. Here the
business aims to stay in the market and just cover it costs.
1. Corporate Social
Responsibility
This objective is set by businesses that consider the interest of their
stakeholders and not only their shareholders when taking decisions.
These company’s give better treatment to workers, customers,
environment etc.
1. Image and Reputation These companies tend to portray themselves in a positive light in front if
their stakeholders. Example: Welfare campaigns, call backs in case of

18. REMEMBER:
Tc=TFC + TVC
ATC= U-shaped curve
AVC= u- shaped curve
Mc is a hockey curve

19. What are Economies of Scale?
• Economies of scale refer to the cost advantage experienced by a firm when it
increases its level of output.
• The advantage arises due to the inverse relationship between the per-unit cost
and the quantity produced.
• The greater the quantity of output produced, the lower the per unit cost
• Economies of scale can be realized by a firm at any stage of the production
process. In this case, production refers to the economic concept of production
and involves all activities related to the commodity, not involving the final
buyer.
• NOTE: Thus, a business can decide to implement economies of scale in
its marketing division by hiring a large number of marketing
professionals. A business can also adopt the same in its input sourcing
division by moving from human labor to machine labor.

20. Effects of Economies of Scale on Production Costs
1. It reduces the per-unit fixed
cost. As a result of increased
production, the fixed cost
gets spread over more output
than before.
2. It reduces per-unit variable
costs. This occurs as the
expanded scale of production
increases the efficiency of the
production process.

21. Types of Economies of Scale
• 1. Internal Economies of Scale
• This refers to economies that are unique to a
firm. For instance, a firm may hold a patent over
a mass production machine, which allows it to
lower its average cost of production more than
other firms in the industry.
• 2. External Economies of Scale
• These refer to economies of scale enjoyed by an
entire industry. For instance, suppose the
government wants to increase steel production.
In order to do so, the government announces that
all steel producers who employ more than 10,000
workers will be given a 20% tax break.
• Thus, firms employing less than 10,000 workers
can potentially lower their average cost of
production by employing more workers. This is
an example of an external economy of scale –
one that affects an entire industry or sector of the
economy.

22. Sources of Economies of Scale
• 1. Purchasing
• Firms might be able to lower average costs by buying the inputs required for the
production process in bulk or from special wholesalers. By negotiating with suppliers
for volume discounts, the purchasing firm takes advantage of economies of scale.
• 2. Managerial
• Firms might be able to lower average costs by improving the management structure
within the firm. The firm might hire better skilled or more experienced managers.
• 3. Technological
• A technological advancement might drastically change the production process. For
instance, fracking completely changed the oil industry a few years ago. However, only
large oil firms that could afford to invest in expensive fracking equipment could take
advantage of the new technology.
• 4. technical EOS
• ↑ specialization, indivisibility, by products EOS, stock EOS
• 5. marketing EOS

23. Diseconomies of Scale

24. • Consider the graph shown above. Any increase in output beyond Q2 leads to a
rise in average costs. This is an example of DEOS – a rise in average costs
due to an increase in the scale of production.
• As firms get larger, they grow in complexity. Such firms need to balance the
economies of scale against the diseconomies of scale. For instance, a firm
might be able to implement certain economies of scale in its marketing division
if it increased output. However, increasing output might result in diseconomies
of scale in the firm’s management division.

25. Shapes of Long-Run Average Cost Curves
• While in the short run firms are limited to operating on a single average cost
curve (corresponding to the level of fixed costs they have chosen), in the long
run when all costs are variable, they can choose to operate on any average
cost curve.
• Thus, the long-run average cost (LRAC) curve is actually based on a group
of short-run average cost (SRAC) curves, each of which represents one
specific level of fixed costs. More precisely, the long-run average cost curve
will be the least expensive average cost curve for any level of output.
• FIGURE shows how the long-run average cost curve is built from a group of
short-run average cost curves. Five short-run-average cost curves appear on
the diagram. Each SRAC curve represents a different level of fixed costs.

26. • For example, you can imagine SRAC1 as a
small factory, SRAC2 as a medium factory,
SRAC3 as a large factory, and SRAC4 and
SRAC5 as very large and ultra-large.
Although this diagram shows only five
SRAC curves, presumably there are an
infinite number of other SRAC curves
between the ones that are shown.
• This family of short-run average cost curves
can be thought of as representing different
choices for a firm that is planning its level of
investment in fixed cost physical capital—
knowing that different choices about capital
investment in the present will cause it to end
up with different short-run average cost
curves in the future.

27. • The long-run average cost curve shows the cost of producing each quantity in the long run,
when the firm can choose its level of fixed costs and thus choose which short-run average
costs it desires. If the firm plans to produce in the long run at an output of Q3, it should make
the set of investments that will lead it to locate on SRAC3, which allows producing q3 at the
lowest cost. A firm that intends to produce Q3 would be foolish to choose the level of fixed
costs at SRAC2 or SRAC4. At SRAC2 the level of fixed costs is too low for producing Q3 at
lowest possible cost, and producing q3 would require adding a very high level of variable costs
and make the average cost very high. At SRAC4, the level of fixed costs is too high for
producing q3 at lowest possible cost, and again average costs would be very high as a result.
• The shape of the long-run cost curve, as drawn in Figure, is fairly common for many
industries. The left-hand portion of the long-run average cost curve, where it is downward-
sloping from output levels Q1 to Q2 to Q3, illustrates the case of economies of scale. In this
portion of the long-run average cost curve, larger scale leads to lower average costs.
• In the middle portion of the long-run average cost curve, the flat portion of the curve around
Q3, economies of scale have been exhausted. In this situation, allowing all inputs to expand
does not much change the average cost of production, and it is called constant returns to
scale. In this range of the LRAC curve, the average cost of production does not change much
as scale rises or falls. The following Clear it Up feature explains where diminishing marginal
returns fit into this analysis.

28. FIRM’S BEHAVIOR

29. Markets
Product
market
Where goods
and services
are bought and
sold
monopoly Oligopoly
Monopolistic
competition
Perfect
conpetition
Factor market
Where FOP
are bought and
sold
Labour market

30. Traditional economic theory of profit maximization
• According to traditional economic theory profit maximisation is the sole objective of
business firms. Profit maximisation means the largest absolute amount of money
profits in given demand and supply conditions.
• Conventional price theory is based upon profit maximisation hypothesis.
• Profit maximisation hypothesis helps not only in predicting the behaviour of business
firms but also the price-output behaviour under different market conditions.
• No other hypothesis can explain and forecast the behaviours of firms better than this
hypothesis. Under perfect competition individual firms have to maximise their profits
at price determined by industry. Under imperfect competition firms search their profit
maximising price output as they are price makers. The profit can be defined as
(revenue - total cost).

31. • A firm will maximise its profit at that level
of output at which the difference
between total revenue and total cost is
maximum.
• Generally conventional price theory
determines profit maximising price-
output in terms of marginal cost (MC)
and marginal revenue (MR).
• Marginal revenue is the addition to total
revenue from the sale of an additional
unit of a commodity. Marginal cost is the
additional unit cost of the commodity.
• 1. MC = MR
• 2. MC must be rising at the point of
equality between MC and MR.
• Let us explain these two conditions. We
take first condition.
• (i) If MC < MR total profits are not
maximised because firm will earn more
profits by increasing production.
• (ii) If MC > MR the level of total profit is
being reduced and firm can increase
profit by decreasing production.
• (iii) If MC = MR the profits could not
increase either by increasing or
decreasing output and hence profits are
maximised.

32. • Now we take the second condition.
• The first condition though a necessary but
not a sufficient condition to maximise profits.
• Therefore, fulfillment of second condition is
also necessary. It is illustrated by Fig.
• The Second condition of profit maximisation
requires that MC be rising at the point of its
intersection with the MR curve.
• This means that the MC curve must cut MR
curve from below i.e., the slope of MC must
be steeper than the slope of MR curve. At
point E both the conditions are satisfied i.e.,
MC = MR and slope of MC > slope of MR.

33. Perfect competition
• Perfect Competition is an idealistic economic theory that asks what a market structure with full equality
between sellers and fully informed consumers would look like
• characteristics:
1. Many buyers and sellers
2. Homogeneous goods
3. Free entry and exit
4. Perfect knowledge
5. Size of the firm is small
6. Substitutes are available
7. Productive efficiency
8. Allocative efficiency
9. No transport cost or advertisement cost
10. May not exist in real world

34. • Example of Perfect Competition
• If there is any example of a market that comes close to perfect competition it is
found in farming.
• A market in which there are a large number of buyers and sellers, little
difference between products, and prices that remain largely unaffected by
market share.
• However, entry into the market is not free and the labor needed to do so is not
entirely mobile since a certain level of experience and expertise is needed in
order to be successful.

35. Short-run price and output determination
MC and MR method TC and TR method

36. Types of determination of profit

37. Shut down cases of PC

38. • With contribution-losses:
• The firm may be in equilibrium and yet incur a loss when price is less than the short-run
average costs, as shown in Figure 2 (C).
• The firm is in equilibrium at point E3 where SMC = MR and SMC cuts MR from below.
• OQ3 is the equilibrium output and OP (=Q3E3) is the equilibrium price.
• Since the average costs Q3B are higher than the price Q3E3, E3B is the loss per unit (Q3B-
Q3E3).
• The total loss is PE3 x E3B = PE3BA. The firm will continue to produce OQ3 output so long
as it is covering its average variable cost plus some of its fixed cost.

39. • Losses-Without/zero contribution
• If the price fig. 2 falls to the level of AVC, the firm will just cover its average variable cost, as
shown in figure 2 (D).
• It is indifferent whether to operate or close down because its losses are the maximum.
• It will pay such a firm to continue producing OQ4 output and incur PE4GF losses rather
than close down in the short-run.
• OQ4 is the shutdown output because if the price falls below OP, the firm will stop
production.
• E4 is, therefore, the shutdown point.

40. • Shut-down
• Figure 2. (E) shows a firm which is unable to cover even its AVC at OQ0 level of output
because the price OP is below the AVC curve.
• It must shut down

41. Price and output determination in long-run
Supernormal profit Normal profit

42. • Supernormal profits to normal profits:
• Here industry is entering supernormal profit
• There will be two reactions:
• new firms will enter the industry
• Existing firms will expand production so their supply increases
• losses to normal profits:
• Here industry is facing losses
• There will be two reactions:
• Some firms will leave the industry
• Existing firms will reduce production so supply decreases

43. MONOPOLY

44. Revenue
curve under
PC
• Firms are price takers
not the price makers
• Homogeneous products
• Constant price levels
P Q TR=P*Q MR=∆P*/∆Q AR=TR/Q
$5 0 0 - -
$5 1 5 5 5
$5 2 10 5 5
$5 3 15 5 5
$5 4 20 5 5

46. Revenue curve under monopoly
• In the perfectly competitive case, the
additional revenue a firm gains from
selling an additional unit—its
marginal revenue—is equal to the
market price.
• The firm’s demand curve, which is a
horizontal line at the market price, is
also its marginal revenue curve.
• But a monopoly firm can sell an
additional unit only by lowering the
price. That fact complicates the
relationship between the monopoly’s
demand curve and its marginal
revenue.

47. When marginal revenue is … then demand is …
positive, price elastic.
negative, price inelastic.
zero, unit price elastic.

48. Definition
• A monopoly market is when a single seller has a majority of the market share.
• This means customers have only one option for buying certain products.
• Certain factors restrict other sellers from entering the market, allowing the
individual seller to maintain a monopoly

49. Characteristics
• Single seller
• Large size
• Heterogeneous

50. • Profit-maximizing behavior is always based on the marginal decision rule:
Additional units of a good should be produced as long as the marginal
revenue of an additional unit exceeds the marginal cost.
• The maximizing solution occurs where marginal revenue equals marginal cost.
• As always, firms seek to maximize economic profit, and costs are measured
in the economic sense of opportunity cost.

51. • Fig. shows a demand curve
and an associated marginal
revenue curve facing a
monopoly firm.
• The marginal cost curve is like
those we derived earlier; it falls
over the range of output in
which the firm experiences
increasing marginal returns,
then rises as the firm
experiences diminishing
marginal returns

53. Types of losses
• Loss with contribution
• The difference between AR=D
curve and AVC curve at a certain
level represents contribution per
unit

54. • Loss without contribution
• The difference between AC and
AVC at the certain level represents
loss per unit
• The difference between AR=D and
AVC at the certain level represents
contribution per unit.

55. • Shutdown point
• The difference between AC and
AVC at the certain level represents
loss per unit
• The difference between AR=D and
AVC at the certain level represents
contribution per unit.

56. Price and output determination in long-run
• A monopoly is able to keep potential rivals out of the market through natural
and artificial barriers to entry. Therefore a monopolist is able to earn same
economic profits in long-run that it was earning in the short run.
• The profits may be categorized as:
• Supernormal
• Normal
• Subnormal/loss

57. Barriers to entry
• Natural monopoly
• High set up cost
• High sunk cost
• Predatory pricing
• Brand loyalty