COST & REVENU CONCEPTS

PRESENTED BY:- PRADEEP MALIK (4151048)

Cost Concept:

It is used for analyzing the cost of a project in short and long run.

• Cost Concepts which are relevant to business operations and decisions can be based on 2 categories

1. Concepts used for accounting purposes

2. Analytical cost concepts

Opportunity cost The opportunity cost may be defined as the expected returns form

the second best use of the resources which foregone due to the scarcity of resources. The opportunity cost is also called alternative cost. Had the resource available been unlimited, there would be no opportunity cost.

Actual Costs Actual costs are those which are actually incurred by the firm in

payment for labor, material, plant, building, etc.

Full Costs includes business costs, opportunity cost and normal profit.

Full Costs

Explicit and Implicit Costs

Explicit costs are those which fall under actual costs entered in the books of accounts

In contrast, there are costs that do not take the form of cash outlays nor do they appear in the accounting system. Such costs are called Implicit or Imputed Costs.

Out of Pocket and Book Costs

The items of which involve cash payments, both recurring and non-recurring, are known as out-of-pocket costs

There are certain actual business costs which do not involve cash payments, but a provision is made in the books of accounts and they are taken into account while making the profit and loss accounts. Such expenses are known as book costs.

Incremental and Sunk Costs

• Incremental costs are closely related to marginal costs but while marginal refers to the cost of the marginal unit of output, incremental costs refers to the total additional cost associated with the expand in output

• Sunk Costs are those which cannot be altered, increased or decreased by varying the rate of output

Total Fixed Costs (TFC) Total Variable Cost (TVC) Total Cost (TC=TFC+TVC) Average Fixed Costs (AFC) Average Variable Cost (AVC) Average Total Cost (ATC=AFC+AVC) Marginal Cost (MC)

TYPES

Fixed Costs(FC)Fixed Cost denotes the costs which do

not vary with the level of production. FC is independent of output.

Eg: Depreciation, Interest Rate, Rent, Taxes

Total fixed cost (TFC): All costs associated with the fixed

input.

Average fixed cost per unit of output: AFC = TFC /Output

Variable Costs(VC)Variable Costs is the rest of total cost, the part

that varies as you produce more or less. It depends on Output.

Eg: Increase of output with labour.

Total variable cost (TVC): All costs associated with the

variable input. Average variable cost- cost per unit of

output: AVC = TVC/ Output

Total costs(TC) The sum of total fixed

costs and total variable costs:

TC = TFC + TVC

Average Total Cost Average total cost per unit of

output:

ATC =AFC + AVC ATC = TC/ Output

Marginal Costs

The additional cost incurred from producing an additional unit of output:

MC = TC Output

MC = TVC Output

Typical Total Cost Curves

TVC,TC is always increasing: First at a decreasing rate. Then at an increasing rate

Typical Average & Marginal Cost Curves

AFC is always declining at a decreasing rate.

ATC and AVC decline at first, reach a minimum, then increase at higher levels of output.

The difference between ATC and AVC is equal to AFC.

MC is generally increasing. MC crosses ATC and AVC at

their minimum point. If MC is below the average

value: Average value will be

decreasing. If MC is above the average

value: Average value will be

increasing.

Short-Run Cost

The ATC curve is also U-shaped. The MC curve is very special.Where AVC is falling, MC is below AVC.

Where AVC is rising, MC is above AVC.

At the minimum AVC, MC equals AVC.

Short-Run Cost

Similarly, where ATC is falling, MC is below ATC.

Where ATC is rising, MC is above ATC.

At the minimum ATC, MC equals ATC.

Short-Run Cost

Cost Curves and Product CurvesThe shapes of a firm’s cost curves are determined by the technology it uses:

MC is at its minimum at the same output level at which marginal product is at its maximum.

When marginal product is rising, marginal cost is falling.

AVC is at its minimum at the same output level at which average product is at its maximum.

When average product is rising, average variable cost is falling.

Long-Run Cost

Short-Run Cost and Long-Run CostThe average cost of producing a given output varies and depends on the firm’s plant size.The larger the plant size, the greater is the output at which ATC is at a minimum.Cindy has 4 different plant sizes: 1, 2, 3, or 4 knitting machines.Each plant has a short-run ATC curve.The firm can compare the ATC for each given output at different plant sizes.

Long-Run Cost

ATC1 is the ATC curve for a plant with 1 knitting machine.

Long-Run Cost

ATC2 is the ATC curve for a plant with 2 knitting machines.

Long-Run Cost

ATC3 is the ATC curve for a plant with 3 knitting machines.

Long-Run Cost

ATC4 is the ATC curve for a plant with 4 knitting machines.

Long-Run Cost

The long-run average cost curve is made up from the lowest ATC for each output level.

So, we want to decide which plant has the lowest cost for producing each output level.

Let’s find the least cost way of producing a given output level.

Suppose that Cindy wants to produce 13 sweaters a day.

Long-Run Cost

13 sweaters a day cost $7.69 each on ATC1.

Long-Run Cost

13 sweaters a day cost $6.80 each on ATC2.

Long-Run Cost

13 sweaters a day cost $7.69 each on ATC3.

Long-Run Cost

13 sweaters a day cost $9.50 each on ATC4.

Long-Run Cost

13 sweaters a day cost $6.80 each on ATC2.The least-cost way of producing 13 sweaters a day

Long-Run Cost

Long-Run Average Cost CurveThe long-run average cost curve is the relationship between the lowest attainable average total cost and ouptut when both the plant size and labor are varied.

The long-run average cost curve is a planning curve that tells the firm the plant size that minimizes the cost of producing a given output range.

Long-Run Cost

Figure 10.8 illustrates the long-run average cost (LRAC) curve.

Long-Run Cost

Economies and Diseconomies of ScaleEconomies of scale: falling long-run average cost as output increases.

Diseconomies of scale: rising long-run average cost as output increases.

Constant returns to scale: constant long-run average cost as output increases.

Revenue Revenue is the money payment

received from the sale of a commodity.

Types of Revenue

1. Total Revenue2. Average Revenue3. Marginal Revenue

Total RevenueTR is defined as the total or aggregate of proceeds to the firm from the sale of a commodity.

Symbolically,TR = P X Q

P = PriceQ = Quantity

Average RevenueAverage Revenue is the revenue per unit of output sold.

Symbolically,AR = TR

QOr, AR = P X Q

QOr, AR = P

AR is always identical with the price.

Marginal Revenue Marginal Revenue is the revenue received

by selling one extra unit of output.OR

Marginal Revenue is the addition made to total revenue when one more unit of output is sold.

MR = Change in Total Revenue Change in Quantity Sold

MR = ΔTRΔ Q

Also, MR n = TR n – TR n-1

Firm’s Revenue curves under Perfect Competition

It is a market situation where a firm is a price taker. There are so many buyers and sellers in the market that no individual buyer or seller can influence the price of a commodity. Any variation in the output supplied by a single firm will not affect the total output of the industry. No individual buyer can influence the price of the commodity by his decision to vary the amount that he would like to buy.

Price in perfect competition market is determined by the free play of the market demand and supply curve.

TR, AR, MR schedule under Perfect Competition

Here, AR=P=dAR=MR

Units sold

Price (P)

TR AR MR

12345

1010101010

1020304050

1010101010

1010101010

Graphical presentation of TR, AR, MR under Perfect

Competition Revenue TR 50

40

30

20

10 P=AR=MR=d

0 1 2 3 4 5 Quantity