cost and revenue

1. Unit III
Cost and Revenue

2. Cost and Revenue
Meaning & Types of Costs1
Cost function and relationship2
Economies of Scale3
Revenue: meaning and concepts4

3. Cost
Meaning and Types

4. Welcome!!
COST

5. Cost refers to the acutal money
spent or acquisition of an asset
taking to account.
Accountant View
Cost refers to the choice faced by
the firm in utilising its resources.
Economicsts View
Cost refers to the summation of all
costs incurred by the firm
Cost
An amount that has to be paid or
given up in order to get something.
Definition
Meaning & Concepts
Cost

6. the set of services provided
by the organisation in a
given period
Time and Utilties
consumed
A Charge for a product or
service received or
delivered
Risk Insured
Exploitable set of
circumstances with
uncertain outcome
Opportunity foregone
A resource is a source or
supply from which benefit
is produced
Resources
The matter from which
something can be made
Material
physical or mental activity
needed to achieve
something, or energy
used to do something.
Effort
Meaning & concept of Cost
Cost

7. Opportunity cost is the next best
alternative foregone
Oppotunity Cost
costs resulting from a change in the
nature of level of business activity
Incremental Cost
those expenses/expenditures that are
actually paid by the firm
Explicit Cost
Implicit costs are a part of opportunity
cost
Implicity Cost
Costs incurred cannot be recovered
Sunk Cost
costs which a firm incurs when it
temporarily stops its operations
Shut-down cost
the cost that a firm incurs to replace or
acquire the same asset now
Replacement Cost
the original price paid by the
management to purchase it in the past
Historical Cost
Different types of costs
Costs

8. The costs which don’t vary with
changing output
Fixed Cost
Costs which depend on the output
produced
Variable Cost
Average cost is the cost per unit of
production/output
Average Cost
Marginal cost is the cost of producing
an extra unit
Marginal Cost
the money value of the total
resources/inputs
Total Cost
Economic costs are related to future
Economic cost
You can simply impress your audience
and add a unique zing.
Short-run Cost
You can simply impress your audience
and add a unique zing.
Long-run Cost
Different types of Costs
Cost

9. Opportunity
Cost
Definition: The cost of the
opportunity foregone for the sake of
current opportunity.
Economic Implication: Deciding to A
implies deciding to to B (i.e., value of
benefits from A > B).
Example: If you invest Rs.1million in
developing a cure for pancreatic
cancer, the opportunity cost is that
you can’t use that money to invest in
developing a cure for skin cancer.
the next best
alternative foregone
the loss of other alternatives
when one alternative is chosen

10. Incremental
Cost
Definition : Incremental costs are
addition to costs resulting from a
change in the nature of level of
business activity.
Economic Implication: it involves the
estimation of the impact of decision
alternatives
Example: Change in distribution
channels adding or deleting a product
in the product line.
“changes in total cost
consequant upon
decision”
avoidable cost (or) escapable
cost (or) differntial costs

11. Explicit Cost
Definition: The cost incurred by a
prouducer on external factors of
production
Economic Implications: important
for calculating the profit and loss
accounts and guide in economic
decision-making.
Example: Interest payment on
borrowed funds, rent payment,
wages, utility expenses etc.
“actual cash payments
for resources”
External factors which
does not owned by him

12. Implicit Cost
Definition: cost of the factors of
production provided by the
entrepreneur himself to his firm.
Economic Implications: It is not
recorded in book account, but
important in certain decisions.
Examples: Rent on idle land,
depreciation on dully depreciated
property still in use, interest on equity
capital etc.
“imputed cost”
It is part of opporutnity cost
It is a theoritical cost

13. Sunk Cost
Definition: Sunk costs refer to the
expenditures that have been already
incurred and cannot be recovered.
Economic Implication: investment
costs incurred before a certain activity
takes place which cannot be
recovered by the possible sale of the
asset they produced.
Example: if you spend money on
advertising to enter an industry, you
can never claim these costs back. If
you buy a machine, you might be able
to sell if you leave the industry
“cannot be recovered
by the possible sale”
Costs incurred in the past
actually are sunk cost
Specific cost

14. Shutdown
Costs
Definition : The costs which a firm
incurs when it temporarily stops its
operations .
Economic Implication: These costs
can be saved when the firm again
start its operations. It helps to avoid
unnecessary expenses
Example: the cost includes fixed
costs, maintenance cost, layoff
expenses etc.
“temporarily stops
its operations”
revenue is equal to its
variable costs

15. Replacement
Cost
Definition: Costs refers to the cost
that a firm incurs to replace or acquire
the same asset now.
Economic Implication: decide
to replace the assets of a company or
a property.
Example: If a firm acquires a machine
for Rs. 20,000 in the year 1990 and
the same machine costs Rs. 40,000
now.
Rs. 40,000 is the replacement cost
“acquire the same
asset now”
replace the assets as it has
same or equal value.

16. Historical
Cost
Definition: Historical cost or original
costs of an asset refers to the original
price paid by the management to
purchase it in the past.
Economic Implication: accounts for
the true economic cost of using
assets
Example: If a firm acquires a machine
for Rs. 20,000 in the year 1990 and
the same machine costs Rs. 40,000
now.
Rs. 20,000 is the Historical cost
acquire the same
asset now
Easy to change colors,
photos and Text.

17. Fixed Costs
(FC)
Definition: The cost that does not
change with an increase or decrease
in the amount of goods or services
produced or sold
Economic Implication: influence the
product cost and, through the cost,
the pricing and profit levels.
Example: Rent for building,
Insurance, etc.,
“the costs which don’t
vary with changing
output”
TFC= TC - TVC
TFC=AFC x Q.

18. Variable
Costs (VC)
Definition : The costs incurred in
Variable costs are those costs that
vary depending on a company's
production volume
Economic implication: Variable
costs stay the same on a cost-per-unit
basis.
Example: raw materials, fuel etc.,
Costs which depend
on the output
produced
Easy to change colors,
photos and Text.

19. Average
Cost (AC)
Definition: Cost computed by dividing
the total of fixed costs and variable
costs by the number of total units
produced.
Economic Implication:
Lower average costs are a potent
competitive advantage
Example: If the total cost of 3 units is
1550. The average cost is 516.66
“per unit cost”
AC= TC/Q
(or)
FC+VC
AC=
Q

20. Marginal
Cost (MC)
Definition: It refers to the change in
total cost per unit change in output
Economic Implication:
Example: If the total cost of 3 units is
1550, and the total cost of 4 units is
1900. The marginal cost of the 4th
unit is 350
“the cost of producing
an extra unit”
∆ TC
MC =
∆Q

21. Total Costs
(TC)
Definition: the sum of the Total fixed
cost and the Total variable cost.
Economic Implication: By dividing
the total costs by the quantity
produces, one gets the average
costs: how much a unit of production
costs
Example: a firm incurring Rs.
10,000 of FC to produce 1,000 units.
(for an average fixed cost per unit
of Rs. 10), and its variable cost per
unit is Rs. 3
“sum of all cost”
TC = TFC + TVC

22. Economic
Cost
Definition: The sum of the explicit
and the implicit costs is referred as
the economic cost
Economic Implication: The costs
considered in decision - making are
usually future costs.
Example: cost of attending college,
the accounting cost includes all
charges such as tuition, books, food,
housing, and other expenditures.
“costs related to
future”
have the nature similar to that
of incremental, imputed
explicit and opportunity costs.

23. Short Run
Cost
Definition: The short run is a situation
where the variable factors of
production are changeable and fixed
costs are not changeable
Economic Implication: only variable
costs and revenues affect the short
run production. Variable costs change
with the output.
Examples: Variable costs include
employee wages and costs of raw
materials.etc.,
“costs in the
short period”
Influence the price only.

24. Long run
Cost
Definition: The long run is a situation
where all main factors of production
are variable
Economic Implication: firms are
able to adjust all costs,
Example: These costs are which
incurred on the fixed assets like land
and building, plant and machinery
etc., Long run costs are same as fixed
costs. Usually, long run costs are
associated with variations in size and
kind of plant.
“all the costs are
variable”
No fixed cost.

25. Cost Function
Meaning and Types

26. The costs are (the value of) the
highest-valued alternative use of
the money spent in hiring them.
Highest value
They are called explicit costs, as
they involve a transfer of money..
Explicit Costs
The costs of using these factors are
(the value of) the highest-valued
alternative uses of the factors
Use value
They are called implicit costs or
imputed costs, as they do not
involve a transfer of money.
Implicit Cost
Cost function
Cost
factors hired or employed by a firm
factors owned by a firm

27. Total Cost
Classification of costs of different factor inputs
Cost function
Sunk Cost - Historical Cost
 Sunk cost is not a (present or future) cost.
 It should have no effect on any present or
future decisions.
Fixed Cost
 no effect on the determination of the
wealth-maximizing output level
 affects the net receipt
Variable Cost
affects the wealth-maximizing output.
affects the net receipt..

28. Output
= ???
Cost Function
describes the relationship between
output and cost
C = FC+VC(x)

29. 01 02
03
0405
06
Efficiency of
Management and Labour
.
Efficiency
Stability of Output
Technology
Utilisation of Fixed Plant
Rate of Output
Size of Plant
Materials and Labour
Prices of Input Factors
Determinants
Determinants of Cost function

30. Total Cost (TC)
Sum of all cost
TC = TFC + TVC
Marginal Cost
(MC)
additional cost due to
additional unit
MC = ∆TC/∆Q
Average Cost
(AC)
per unit cost
AC = TC/Q
asoutputchanges
Measure of costs
Short–Run Cost

31. Total Cost
the whole amount of payments to all
factors used in producing a given
amount of output (Q), composed of:
 Total fixed cost (TFC): is the
whole amount of payments to
fixed factors.
 Total variable cost (TVC): is the
whole amount of payments to
variable factors.
TC = TFC +TVC
a constant
independent
of output
TVC = w x L

32. Average
Cost/Average
Total Cost (ATC)
is the cost per unit of output,
composed of :
 average fixed cost (AFC):
the fixed cost per unit of
output.
 average variable cost (AVC):
the variable cost per unit of
output
AVCAFC
Q
TVCTFC
Q
TC
ATC 


Q
TFC
AFC 
AP
w
L
Q
w
L
Q
L
Lw
Q
Lw
Q
TVC
AVC 





33. Average
Cost/Average
Total Cost (ATC)
AFC curve drops continuously.
(AFC = TFC/Q)
AVC curve is U-shaped.
( AVC = w/AP and AP is inverted-
U shaped.)
ATC curve and AVC curve will
come closer and closer as the
amount of output increases
(ATC = AFC + AVC and AFC
drops continuously).

34. Marginal
Cost (MC)
the change in total cost for
producing an additional unit of
output, composed of :
 marginal fixed cost (MFC): is the
change in fixed cost
 for producing an additional unit of
output
 marginal variable cost (MVC): is
the change in variable cost for
producing an additional unit of
output.
0



Q
TFC
MFC
MP
w
L
Q
w
L
Q
L
Lw
Q
Lw
Q
TVC
MVC 














Q
TVCTFC
Q
TC
MC






MVCMFCMC 

35. Marginal
Cost (MC)
MC or MVC
curve is
U-shaped
As TFC is a constant, MFC = 0. So
MC = MVC
MC = MVC = w/MP. As MP curve is
inverted-U shaped, MC
or MVC curve is U-shaped.
MC curve passes through the
minimum points of AVC curve
and ATC curve.

36. Derivation of
Total Cost (TC)
MC curve (= MVC curve)
= Slope of TC curve & TVC
curve.
Notice the points
where MC = mini.;
MC = AVC and
MC = ATC.

37. Derivation of
Total Cost (TC)
The firm enjoys economies of
scale at the beginning
LRAC & LRMC 
As the scale of production 
further, the firm suffers
diseconomies of scale
LRAC & LRMC

38. Derivation of
Total Cost (TC)
The firm enjoys economies of
scale at the beginning
LRAC & LRMC 
As the scale of production 
further, the firm suffers
diseconomies of scale
LRAC & LRMC

39. LRMC = slope of LRTC
Notice the points where
LRMC = mini. and LRMC =
LRAC.
Slope
=LRMC
=LRAC

40. Economies of Scale
Internal and External Economies

41. Definition
Economies of Scale
Economies of scale is an
economics term that
describes a competitive
advantage that large entities
have over smaller entities
The reduction in long-run average and marginal costs
arising from an increase in size of an operating unit (a
factory or plant, for example).
Economics of scale can be internal to an organization
(cost reduction due to technological and management
factors) or external (cost reduction due to the effect of
technology in an industry). See also diseconomies of
scale.

42. Economies
arising out of
large scale
production
Economies of
scale as synonyms
with returns to
scale.
Stigler
There are its
diseconomies to
scale
Marshall
Economies arise
purely due to
endogenous facors
relating to efficiency
of the entrepreneur
or his managerial
talents

43. all those benefits which accrue to
all the firms operating in a given
industry
External Economies
which can be had after paying less
prices for the factors used in the
process of production and
distribution...
Pecuniary Economy
which are open to a single factory,
or a single firm independently of the
action of other firms.
Internal Economies
which are associated with the
reduction of physical quantity of
inputs, raw materials, various types
of labour and capital etc..
Real Economy
Internal and External Economies
Economies of Scale
External EconomiesInternal Economies

44. Revenue
Average Revenue, Marginal Revenue and Total
Revenue

45. Total Revenue
(TR)
Definition: Total revenue is the
sum of all sales, receipts or
income of a firm
According to Stonier and
Hague, “Total revenue at any
output is equal to price per unit
multiplied by quantity sold.”
Example: If P = Rs. 100
No. of unit sold = 20
TR = AR x Q
2000 = 100 x 20
“sum of all sales”
TR = AR x Q

46. Average
Revenue (AR)
Definition: revenue obtained by the
seller by selling the per unit
commodity.
Economic Implication: an average
curve which shows that price is a
function of quantity demanded. it is
also a demand curve
Example: If P = Rs. 100
Output = 20
AR = (P x Q)/Q
= (100 x 20 ) 20
= 20
“per unit revenue”
AR= TR/Q
(or)
Price x Output
AR =
Output

47. Marginal
Revenue
(MR)
Definition: the change in total
revenue which results from the sale of
one more or one less unit of output
Economic Implication:
Example: If the total Revenue
increased from Rs. 100 to 150 due to
selling goods from 10 to 15 . The
marginal revenue of the 5 unit is Rs.
50
“the revenue of selling
an extra unit”
∆ TR
MR =
∆Q
MRn = TRn – TRn-1

48. Unit (Q) TR/Q (or) Price PQ (or) TR
TRn-TRn-1 (or)
MR
1 10 10 10
2 9 18 8
3 8 24 6
4 7 28 4
5 6 30 2
6 5 30 0
7 4 28 -2
Average Revenue , Total Revenue and Marginal Revenue
Revenue Table

49. Marginal
Revenue
(MR)

50. TR, AR and MR curves under Perfect Competition
Revenue Curve
AR=MRP
Output
TR
O X
X
Y
0 Output
Revenue
Revenue

51. AR and MR
under
Imperfect
Competition
MR
AR
X
Y
Output
R
e
v
e
n
u
e
0
Both AR and MR are derived
from TR
AR and MR are both downward
sloping.
Slope of MR is double the
slope of AR
AR is always positive but same
is not true about MR as
MR may be positive,
zero or even negative

52. Thank you