7b5f53 Analysis of Cost and Revenue 25-04

7/30/2019 7b5f53 Analysis of Cost and Revenue 25-04

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Analysis of Cost andRevenue


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Short runA period of time so short that the firm cannot

alter the quantity of some of its inputs

Typically plant and equipment are fixedinputs in the short run

Fixed inputs determine the scale of thefirms operation


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SHORT-RUN COSTS

Fixed costs and variable costs

Total costs Short run fixed cost (SFC)

Short run variable cost (SVC)

Short run total cost (STC = SFC + SVC)


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Costs In buying factor inputs, the firm

will incur costs

Costs are classified as:

Fixed costs costs that are not relateddirectly to production rent, rates,insurance costs, admin costs. They canchange but not in relation to output

Variable Costs costs directly relatedto variations in output. Raw materialsprimarily


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Costs 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 or

one fewer units of production

MC= TC n

TCn-1 units


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Output Fixedcost

SFC

Variablecost

SVC

Total cost

STC

Marginalcost

SMC

Averagecost

SAC

0 30 0 30

1 30 22 52 22 52

2 30 38 68 16 34

3 30 48 78 10 26

4 30 61 91 13 22.75

5 30 79 109 18 21.80

6 30 102 132 23 22

7 30 131 161 29 23

8 30 166 196 35 24.50

9 30 207 237 41 26.33

10 30 255 285 48 28.50

Example


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0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

STC

TVC

SFC

Total costs for firm X

SVC

f f


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0

20

40

60

80

100

STC

TVC

SFC

Total costs for firm X

Diminishing marginalreturns set in here

SVC


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Output (Q)

Costs(

)

SAFC

SAVC

SMC

x

SAC

z

y

Average and marginal costs


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Marginal and Average CostsAs Q increases if

MCAC AC is rising

So, when MC=AC AC is at its

minimum The above also applies to MC and

AVC


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Long-run Cost Curves Long-run cost curves all factors are variable, so

there are no fixed costs and all costs are variable. Economies and diseconomies of scale

benefits to a larger scale of operations

specialization, purchasingvolume, efficient use of capital, design and development costs

costs of a larger scale of operation coordination problems

LR cost curves are U-shaped if a productionprocess is characterized by first by economies ofscale, and then diseconomies of scale.

Since capital can be varied, the long-run costcurves describe the costs with changing the scaleof operations (reducing or increasing plant size).


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The long-run cost curve is constructed from

various short-run cost curves.

Remember increasing capital makes labor moreproductive, so increase plant size makes labormore productive and decreases marginal costs

Even though marginal costs decline, average

costs may go up or down because of the cost ofcapital and labor are added together to calculateaverage costs.

Fi 7 A T t l C t i th Sh t d L


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Figure 7 Average Total Cost in the Short and LongRun

Copyright 2004 South-Western

Quantity ofCars per Day

0

AverageTotalCost

1,200

$12,000

ATC in shortrun with

small factoryATC in short

run withmedium factory


large factory

ATC in long run

Fi 7 A T t l C t i th Sh t d L


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Figure 7 Average Total Cost in the Short and LongRun

Copyright 2004 South-Western

Quantity ofCars per Day

0

AverageTotalCost

1,200

$12,000

1,000

10,000Economies

ofscale


small factoryATC in short

run withmedium factory


large factory ATC in long run

Diseconomiesof

scale

Constantreturns to

scale


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OutputO

Co

sts

Long-run average and marginal costs

LRMC

LRAC

Initial economies of scale,then diseconomies of scale


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Short-Run & Long-Run Marginal Cost Curves

AC(y)

MC(y)$/output unit

y

SRMCs


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Revenue

Total revenue the total amount receivedfrom selling a given output

TR = P x QAverage Revenue the average amount

received from selling each unit

AR = TR / Q

Marginal revenue the amount receivedfrom selling one extra unitof output

MR = TRn TRn-1 units


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Profit

Profit = TR TC

The reward for enterprise Profits help in the process of directing

resources to alternative uses in free

markets Relating price to costs helps a firm to

assess profitability in production


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Profit

Normal Profit the minimum amount required tokeep a firm in its current line of production

Abnormal or Supernormal profit

profit madeover and above normal profit

Abnormal profit may exist in situations wherefirms have market power

Abnormal profits may indicate the existence ofwelfare losses

Could be taxed away without altering resourceallocation


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Profit

Sub-normal Profit profit belownormal 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!)


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Profit

Assumption that firms aim to maximise

profit

May not always hold true

there are other objectives

Profit maximising output would bewhere MC = MR

7b5f53 Analysis of Cost and Revenue 25-04

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