Description
The Basic Step of Cost & Revenue Analysis.
Cost and Revenue Analysis
Concept of Cost
? Expense incurred on the factors of production is known as the cost of production. ? Costs are taken as function of output. ? Cost is categorized in two part. As:
? Economic Cost ? Accounting Cost
Economic Costs
Implicit /Opportunity Cost :
? Inputs owned by owner and used them by own firm in the production process. Such as :
• Implicit cost includes rent which could be earned by renting out the entrepreneur’s own land which is used for own Business purpose.
Implicit cost include the salary that the entrepreneur could earn from working for someone else as manager.
•
Accounting Cost ? Explicit Cost ? Out of pocket expenditures of the firm to purchase or hire the inputs requires in production. Such as :
? Wages for Labour ? Interest on borrowed capital ? Rent on land and buildings
Short Run and Long Run Costs:
? In short Run some factors are fixed and some are variable therefore cost is divided into two parts: ? Fixed Costs: (It do not vary between zero and a certain level of output.) ? Variable Costs: (It do vary with the variation in output)
? In long run all costs are variable because of variable factors due to change in output.
Total Cost :
It covers fixed cost and variable cost.
Fixed Cost
? Total Fixed Cost
? Fixed cost is the cost of employing fixed factors ( machinery, building).
Y
0
OUTPUT
TFC
? Fixed cost is a fixed amount which must be incurred by the firm at large output and arsmall or Zero and as well
X
Total Variable Cost (TVC) Y
TC,TFC,TVC
TC TVC Variable cost is incurred on the employment of variable factors like raw material, fuel, TFC Labour, maintenance. It is also called prime and direct X Cost. ? TVC originates from 0, Indicating zero cost at nil Output output. ? Total Cost (TC) ? TC = TFC+TVC It increases as with an increase in the level of output, as TC is mainly based on TVC.
TC,TVC,TFC
Output Q TFC Labour N0. TVC W*N0 TC = TFC+ TVC
0 10
140 140
0 7
-70
140 210
20
30 40 50 60 70
140
140 140 140 140 140
11
18 28 42 72 112
110
180 280 450 720 1120
250
320 420 590 860 1260
Average Cost
Q 0
10
20 30 40 50
AFC AVC 14. 0
7.0 4.7 3.5 2.8
AC 21.0
12.5 10.7 10.5 11.8
MC 7
4 7 10 17
7
5.5 6.0 7.0 9.0
? AFC = TFC Q ?AVC = TVC Q ?ATC = AVC + AFC
? MC =
60
2.3
12.0
14.3
27
TC Q
Incremental Cost :
?These costs are incurred when the business activity is changed (change in product line, addition or replacement of a machine, changes in distribution channels) which can be avoided by not bringing changes in production line. ? These incremental costs are avoidable costs or controllable costs.
Sunk Cost:
? It is an expenditure that has been incurred and can not be recovered.
? Expenditure that have been made in the past or that must be paid in the future as part of contractual agreement.
? Example - The cost of inventory and future rental payments for warehouse that must be paid as part of a long-term lease agreement. ? Thus sunk costs unavoidable costs. are uncontrollable and
Concept of Revenue
? The amount of money that the producer receives in exchange for the sale of goods is called producer’s revenue or receipts.
Total Revenue (TR)
?TR= Q X P
? Total Revenue = Number of unit sold
x Price of commodity
Marginal Revenue
? Addition to total revenue by selling ‘n’ units of product. TR Q ? MR is change in total revenue associated with a change in quantity sold. ? MR =
Average Revenue
?Average revenue is the revenue that a firm gets, per unit of the good sold.
? AR = TR = P X Q = P Q Q Q= number of units of good sold. ? In economics, AR and price are used synonymously.
Profit
? Profit = Total Revenue - Total Cost Economic Profit = Total Revenue – Economic Cost Economic Cost = Accounting Cost + Opportunity Cost (Implicit Cost)
Accounting Cost = Explicit Cost (Explicit Cash outflow)
Profit as motive of Business :
Example :
? Wages of helpers ? Rent
? ? ? ? ? Cost of Cloth Other accessories Accounting Cost Owner’s time Economic Cost
= =
= = = = =
Rs.50,000/Rs.12,000/Rs.26,000/Rs.5,000/Rs.93,000/Rs.20,000/(Rs.93,000/+20,000/)
=
(Rs.113,000/-)
Profit Maximizing Level of Output
Q TR TC TR-TC
10 20
30 40 50 60
90 160
210 240 250 240
70 120
150 160 225 300
20 40
60 80 25 -60
350 300
TR, TC, Profit
? The quantity at which profit is the highest 40. ? Gap between TR and TC is 80 at 40 Q.
250
200 150 100 50
.
.
Break even point
. .
.
TC
TR
. . . . . .
10 20 30 40 50 60 Quantity
0
Economies and Diseconomies
? Economies refers to cost of advantages. ? Cost advantages may result because of two reasons:
? Extending the scale of production (Economies of Scale) ? Exploring the scope of production (Economies of Scope)
Economies and Diseconomies of Scale
? When a business firm expands its scale of production to earn profit, it derives many economies of large scale production, which in turn help in lowering the cost of production and increasing its productivity. ?When a business firm over utilizes these economies, it may convert into diseconomies, cost disadvantage.
Example
? Suppose a trader incurs an expenditure of Rs.20,000/- on installing a stone cutter machine. ? If he cuts 10,000 pieces of stone: ? AFC= 20,000/10,000 = Rs. 2/? If he cuts 20,000 pieces AFC = 20,000/20,000 = Rs. 1/-
Sources of Economies
? Specialization and division of Labor ? Technical Economies arises from the greater efficiency of large size of plants and capital equipments which large firms can afford not small ones. ? Production Economies -In the case of large firm they can obtain backward and forward linkages on their own.
? Managerial Economies (managerial efficiency increases because of separate departments) ? Marketing Economies. (Large firm can obtain raw material at low cost because it needed in bulk quantity.) ? Financial Economies (Large firm with a large asset base and good will is able to secure the necessary funds.
? Risk and Survival Economies (at the point of stagnation in demand of product large firm can enter into diversified production but small firm can not)
Source of Diseconomies:
? Inefficiency of Management because the cost of gathering, organizing and reviewing information on all aspects of a large firm may increase more rapidly than output. Managing large number of employee is also costly. ? Transportation Cost also one of the diseconomies as the Firm consolidates two or more geographically dispersed plants, production cost may decline but transportation cost will increase.
? Large firm need more labour resultantly to meet demand it has to pay higher wages which will offset other sources of cost reduction.
Economies of Scope
?Firms often find that per-unit of costs are lower than two or more products are produced. ?ExampleA firm can produce both stationary and notebook paper . The cost of Rs.50,000 per 1,000 rims of paper and Rs.30,000 per 1,000 rims of notebook paper. If firm produces both type of paper the cost would be Rs.70,000/-
? A measure of economies of scope? S = TC(QA)+TC(QB) - TC(QA,QB) TC(QA,QB)
S = 50,000 +30,000 – 70,000 70,000
= 0.14
14 percent reduction in total cost if both the products will be produced.
doc_368708135.ppt
The Basic Step of Cost & Revenue Analysis.
Cost and Revenue Analysis
Concept of Cost
? Expense incurred on the factors of production is known as the cost of production. ? Costs are taken as function of output. ? Cost is categorized in two part. As:
? Economic Cost ? Accounting Cost
Economic Costs
Implicit /Opportunity Cost :
? Inputs owned by owner and used them by own firm in the production process. Such as :
• Implicit cost includes rent which could be earned by renting out the entrepreneur’s own land which is used for own Business purpose.
Implicit cost include the salary that the entrepreneur could earn from working for someone else as manager.
•
Accounting Cost ? Explicit Cost ? Out of pocket expenditures of the firm to purchase or hire the inputs requires in production. Such as :
? Wages for Labour ? Interest on borrowed capital ? Rent on land and buildings
Short Run and Long Run Costs:
? In short Run some factors are fixed and some are variable therefore cost is divided into two parts: ? Fixed Costs: (It do not vary between zero and a certain level of output.) ? Variable Costs: (It do vary with the variation in output)
? In long run all costs are variable because of variable factors due to change in output.
Total Cost :
It covers fixed cost and variable cost.
Fixed Cost
? Total Fixed Cost
? Fixed cost is the cost of employing fixed factors ( machinery, building).
Y
0
OUTPUT
TFC
? Fixed cost is a fixed amount which must be incurred by the firm at large output and arsmall or Zero and as well
X
Total Variable Cost (TVC) Y
TC,TFC,TVC
TC TVC Variable cost is incurred on the employment of variable factors like raw material, fuel, TFC Labour, maintenance. It is also called prime and direct X Cost. ? TVC originates from 0, Indicating zero cost at nil Output output. ? Total Cost (TC) ? TC = TFC+TVC It increases as with an increase in the level of output, as TC is mainly based on TVC.
TC,TVC,TFC
Output Q TFC Labour N0. TVC W*N0 TC = TFC+ TVC
0 10
140 140
0 7
-70
140 210
20
30 40 50 60 70
140
140 140 140 140 140
11
18 28 42 72 112
110
180 280 450 720 1120
250
320 420 590 860 1260
Average Cost
Q 0
10
20 30 40 50
AFC AVC 14. 0
7.0 4.7 3.5 2.8
AC 21.0
12.5 10.7 10.5 11.8
MC 7
4 7 10 17
7
5.5 6.0 7.0 9.0
? AFC = TFC Q ?AVC = TVC Q ?ATC = AVC + AFC
? MC =
60
2.3
12.0
14.3
27
TC Q
Incremental Cost :
?These costs are incurred when the business activity is changed (change in product line, addition or replacement of a machine, changes in distribution channels) which can be avoided by not bringing changes in production line. ? These incremental costs are avoidable costs or controllable costs.
Sunk Cost:
? It is an expenditure that has been incurred and can not be recovered.
? Expenditure that have been made in the past or that must be paid in the future as part of contractual agreement.
? Example - The cost of inventory and future rental payments for warehouse that must be paid as part of a long-term lease agreement. ? Thus sunk costs unavoidable costs. are uncontrollable and
Concept of Revenue
? The amount of money that the producer receives in exchange for the sale of goods is called producer’s revenue or receipts.
Total Revenue (TR)
?TR= Q X P
? Total Revenue = Number of unit sold
x Price of commodity
Marginal Revenue
? Addition to total revenue by selling ‘n’ units of product. TR Q ? MR is change in total revenue associated with a change in quantity sold. ? MR =
Average Revenue
?Average revenue is the revenue that a firm gets, per unit of the good sold.
? AR = TR = P X Q = P Q Q Q= number of units of good sold. ? In economics, AR and price are used synonymously.
Profit
? Profit = Total Revenue - Total Cost Economic Profit = Total Revenue – Economic Cost Economic Cost = Accounting Cost + Opportunity Cost (Implicit Cost)
Accounting Cost = Explicit Cost (Explicit Cash outflow)
Profit as motive of Business :
Example :
? Wages of helpers ? Rent
? ? ? ? ? Cost of Cloth Other accessories Accounting Cost Owner’s time Economic Cost
= =
= = = = =
Rs.50,000/Rs.12,000/Rs.26,000/Rs.5,000/Rs.93,000/Rs.20,000/(Rs.93,000/+20,000/)
=
(Rs.113,000/-)
Profit Maximizing Level of Output
Q TR TC TR-TC
10 20
30 40 50 60
90 160
210 240 250 240
70 120
150 160 225 300
20 40
60 80 25 -60
350 300
TR, TC, Profit
? The quantity at which profit is the highest 40. ? Gap between TR and TC is 80 at 40 Q.
250
200 150 100 50
.
.
Break even point
. .
.
TC
TR
. . . . . .
10 20 30 40 50 60 Quantity
0
Economies and Diseconomies
? Economies refers to cost of advantages. ? Cost advantages may result because of two reasons:
? Extending the scale of production (Economies of Scale) ? Exploring the scope of production (Economies of Scope)
Economies and Diseconomies of Scale
? When a business firm expands its scale of production to earn profit, it derives many economies of large scale production, which in turn help in lowering the cost of production and increasing its productivity. ?When a business firm over utilizes these economies, it may convert into diseconomies, cost disadvantage.
Example
? Suppose a trader incurs an expenditure of Rs.20,000/- on installing a stone cutter machine. ? If he cuts 10,000 pieces of stone: ? AFC= 20,000/10,000 = Rs. 2/? If he cuts 20,000 pieces AFC = 20,000/20,000 = Rs. 1/-
Sources of Economies
? Specialization and division of Labor ? Technical Economies arises from the greater efficiency of large size of plants and capital equipments which large firms can afford not small ones. ? Production Economies -In the case of large firm they can obtain backward and forward linkages on their own.
? Managerial Economies (managerial efficiency increases because of separate departments) ? Marketing Economies. (Large firm can obtain raw material at low cost because it needed in bulk quantity.) ? Financial Economies (Large firm with a large asset base and good will is able to secure the necessary funds.
? Risk and Survival Economies (at the point of stagnation in demand of product large firm can enter into diversified production but small firm can not)
Source of Diseconomies:
? Inefficiency of Management because the cost of gathering, organizing and reviewing information on all aspects of a large firm may increase more rapidly than output. Managing large number of employee is also costly. ? Transportation Cost also one of the diseconomies as the Firm consolidates two or more geographically dispersed plants, production cost may decline but transportation cost will increase.
? Large firm need more labour resultantly to meet demand it has to pay higher wages which will offset other sources of cost reduction.
Economies of Scope
?Firms often find that per-unit of costs are lower than two or more products are produced. ?ExampleA firm can produce both stationary and notebook paper . The cost of Rs.50,000 per 1,000 rims of paper and Rs.30,000 per 1,000 rims of notebook paper. If firm produces both type of paper the cost would be Rs.70,000/-
? A measure of economies of scope? S = TC(QA)+TC(QB) - TC(QA,QB) TC(QA,QB)
S = 50,000 +30,000 – 70,000 70,000
= 0.14
14 percent reduction in total cost if both the products will be produced.
doc_368708135.ppt