Costs and Profit

7/29/2019 Costs and Profit

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Costs and Profit

1. Profit determination

Revenue


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Costs and Profit


Revenue-

Income earned from sales.

Total Revenue Gross income from all sales


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Profit


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Costs and Profit


Profit-

The amount remaining when costs are

subtracted from revenue.


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Costs and Profit


Costs

a) Explicit Costs

b) Implicit Costs


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Costs and Profit


Costs

a) Explicit Costs

Explicit costs involve an actual payment of money

b) Implicit Costs


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Costs and Profit


Costs

a) Explicit Costs

Explicit costs involve an actual payment of money

b) Implicit CostsImplicit costs are those that you know you bear,

but you do not actually pay.


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Costs and Profit

Revenue

- Explicit Costs

Financial Profit (or Accounting Profit, or Simple Profit)


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Costs and Profit

Revenue

- Explicit Costs

Financial Profit (or Accounting Profit, or Simple Profit)- Implicit Costs

Economic Profit


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Costs and Profit

Four major costs

All of the major costs are

Explicit Costs


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Costs and Profit

Four major costs

Fixed Cost (FC)


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Costs and Profit

Four major costs

Fixed Cost (FC)

Costs that remain the same as the

number of units produced changes.


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Costs and Profit

Four major costs

Fixed Cost (FC)

Variable Cost (VC)


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Costs and Profit

Four major costs

Fixed cost (FC)

Variable cost (VC)

Costs that change as the numberof units produced changes


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Costs and Profit

Four major costs

Fixed Cost (FC)

Variable Cost (VC)

Total Cost (TC)


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Costs and Profit

Four major costs

Fixed Cost (FC)

Variable Cost (VC)

Total Cost (TC)The total cost of production, equal

to Fixed Cost plus Variable Cost

(FC + VC = TC)


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Costs and Profit

Four major costs

Fixed Cost (FC)

Variable Cost (VC)

Total Cost (TC)Marginal Cost (MC)

d f


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Costs and Profit

Four major costs

Fixed Cost (FC)

Variable Cost (VC)

Total Cost (TC)Marginal Cost (MC)

The cost of producing one additional

unit. The formula for marginal cost isMC = TC/ Units


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Total Cost Curves

Cost

Units Produced

0

d fi


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Costs and Profit

Three minor costs

Average Fixed Cost (AFC)

C d P fi


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Costs and Profit

Three minor costs


Fixed cost divided by units produced

C d P fi


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Costs and Profit

Three minor costs


Average Variable Cost (AVC)

C d P fi


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Costs and Profit

Three minor costs



Variable Cost divided by units produced

C t d P fit


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Costs and Profit

Three minor costs



Average Total Cost (ATC)

C t d P fit


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Costs and Profit

Three minor costs



Average Total Cost (ATC)-

Total Cost divided by units

produced (or AFC + AVC = ATC)


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Average Cost Curves

Cost

Units Produced

0

C t d P fit


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Costs and Profit

The Point of Diminishing Returns

That point in a continuing production

setting where the continued application of

variable cost resources results in

production beginning to increase at a

decreasing rate.

C t d P fit


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Costs and Profit

Long Run and Short Run are not specific time

periods.

The Short Run is a production period that is too

short to allow for fixed-cost assets to be changed.

The Long Run is an average of two or more short

run scenarios.

Production always takes place during a short run.

C t d P fit


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Costs and Profit

Returns to Scale

In a production setting, costs are accounted for inconstant amounts. Rather than figuring out how

much each unit costs, businesses keep track of howmany units are produced per dollar (or thousand

dollars, or million dollars).

This increment of costs is referred to as the scaleby which we measure production. The units

produced are referred to as returns to scale.

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Returns to Scale

There are three possible returns.1. Increasing (positive) returns to scale When

each additional dollar spent results in more

additional units being produced.

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Returns to Scale


each additional dollar spent results in more

additional units being produced.2. Constant (neutral) Returns to Scale - When each

additional dollar spent results in the same

number of additional units being produced.

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Costs and Profit

Returns to Scale


each additional dollar spent results in moreadditional units being produced.

2. Constant (neutral) Returns to Scale - When eachadditional dollar spent results in the same

number of additional units being produced.

3. Decreasing (negative) Returns to Scale - Wheneach additional dollar spent results in fewer

additional units being produced.

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Returns to Scale

When viewed on the Average Total Cost (ATC) curve,the three sections are fairly obvious.

1. As long as the curve is descending, we are in the

Increasing Returns range.

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Costs and Profit

Returns to Scale



Increasing Returns range.2. When the curve levels and is parallel toX, we

are in the Constant Returns range.

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Costs and Profit

Returns to Scale



Increasing Returns range.2. When the curve levels and is parallel toX, we

are in the Constant Returns range.

3. When the curve begins to rise, we are in theDecreasing Returns range.


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Economy of Scale

Cost

Units Produced

0

Costs and Profit


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Costs and Profit

Returns to Scale

Using the Average Total Cost (ATC) curve, it is alsoeasy to identify the area of greatest efficiency of

production.

This is known as Economy of Scale.

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Economy of Scale

Cost savings that are due to a firms large size or highlevels of production output.

There are four things that result in cost savings thatlarge firms can do, and smaller firms cannot.

These are the four reasons for Economy of Scale.

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Economy of Scale

Four reasons for Economy of Scale1. Bulk Rate Discounts

Costs and Profit


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Costs and Profit

Economy of Scale


2. Efficient Use of Human Resources

Costs and Profit


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Costs and Profit

Economy of Scale



3. Efficient Use of Capital Equipment

Costs and Profit


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Costs and Profit

Economy of Scale



3. Efficient Use of Capital Equipment4. Efficient Use of By-Products

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Costs and Profit

Profit Determination

There are two basic methods of calculating profit,and determining the most profitable point of

production (PMLPprofit maximizing level of

production).1. Total Cost basis

2. Marginal Cost basis



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Total Cost Basis

C

ost

Units Produced

0



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Marginal Cost Basis

C

ost

Units Produced

0

Costs and Profit

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