Cost and Revenue Analysis

7/30/2019 Cost and Revenue Analysis

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Cost and Revenue

Analysis


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Concept of Cost

Expense incurred on the factors of prod-

uction 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


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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 earnedby renting out the entrepreneurs own land which isused for own Business purpose.

Implicit cost include the salary that theentrepreneur could earn from working for someoneelse as manager.


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Accounting Cost -

Explicit Cost -

Out of pocket expenditures of the

firm to purchase or hire the inputsrequires in production. Such as :

Wages for Labour Interest on borrowed capital

Rent on land and buildings


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Short Run and Long Run Costs:

In short Run some factors are fixed and

some are variable therefore cost is dividedinto two parts:

Fixed Costs: (It do not vary betweenzero and a certain level of output.)

Variable Costs: (It do vary with thevariation in output)

In long run all costs are variable because ofvariable factors due to change in output.


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Total Cost:

It covers fixed cost and variable cost.

TotalFixed Cost Fixed cost is the cost

of employing fixed factors( machinery, building).

Fixed cost is a fixed

amount which must beincurred by the firm at

large output and arsmall or Zero and as well

TFC

Y

X

OUTPUT

Fixed Cost

0


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Total Variable Cost(TVC)TC,TFC,TVC

Variable cost is incurred

on the employment of variable

factors like raw material, fuel,

Labour, maintenance. It is also

called prime and directCost. TVC originates from 0,

Indicating zero cost at nil

output. Total Cost (TC)

TC = TFC+TVC It increases as with an increase in thelevel of output, as TC is mainly based on TVC.

TFC

Y

X

Output

TVCTC


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TC,TVC,TFCOutput

Q

TFC Labour

N0.

TVC

W*N0

TC =

TFC+

TVC

0 140 0 -- 140

10 140 7 70 210

20 140 11 110 250

30 140 18 180 320

40 140 28 280 420

50 140 42 450 590

60 140 72 720 860

70 140 112 1120 1260


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Average Cost

Q AFC AVC AC MC

0 - - - -

10 14.0

7 21.0 7

20 7.0 5.5 12.5 4

30 4.7 6.0 10.7 7

40 3.5 7.0 10.5 10

50 2.8 9.0 11.8 17

60 2.3 12.0 14.3 27

AFC = TFC

Q

AVC = TVC

Q

ATC = AVC + AFC

MC = TC

Q


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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 avoidedby not bringing changes in production line.

These incremental costs are avoidable costs orcontrollable costs.


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Sunk Cost: It is an expenditure that has been incurred and

can not be recovered.

Expenditure that have been made in the past orthat must be paid in the future as part ofcontractual agreement.

Example - The cost of inventory and futurerental payments for warehouse that must bepaid as part of a long-term lease agreement.

Thus sunk costs are uncontrollable andunavoidable costs.


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Concept of Revenue

The amount of money that the producerreceives in exchange for the sale of

goods is called producers revenue or

receipts.


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Total Revenue (TR)

TR= Q X P

Total Revenue = Number of unit sold

x Price of commodity


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Marginal Revenue

Addition to total revenue by selling n units ofproduct.

MR = TR

Q

MR is change in total revenue associated witha change in quantity sold.


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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.


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Profit

Profit = Total Revenue - Total

Cost

Economic Profit = Total Revenue

Economic CostEconomic Cost = Accounting Cost+ Opportunity Cost (Implicit Cost)

Accounting Cost = Explicit Cost(Explicit Cash outflow)


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Profit as motive of Business :

Example :

Wages of helpers = Rs.50,000/-

Rent = Rs.12,000/-

Cost of Cloth = Rs.26,000/-

Other accessories = Rs.5,000/-

Accounting Cost = Rs.93,000/-

Owners time = Rs.20,000/-

Economic Cost = (Rs.93,000/+20,000/)

= (Rs.113,000/-)


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Profit Maximizing Levelof Output

Q TR TC TR-TC

10 90 70 20

20 160 120 40

30 210 150 60

40 240 160 80

50 250 225 25

60 240 300 -60


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TR, TC, Profit

The quantity

at which profit is

the highest 40.

Gap between

TR and TC is 80 at

40 Q.

Quantity

350

300

250

200

150

100

50

0 10 20 30 40 50 60

.

.

..

.

.

. ..

.

Breakevenpoint

.TC

TR


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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)


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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 productionand increasing its productivity.

When a business firm over utilizes theseeconomies, it may convert into diseconomies,

cost disadvantage.


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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/-


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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 forwardlinkages on their own.


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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)


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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 theFirm 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.


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Economies of Scope

Firms often find that per-unit of costs are lower

than two or more products are produced.

Example-

A 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/-


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A measure of economies of scope-

S = TC(QA)+TC(QB) - TC(QA,QB)

TC(QA,QB)

S = 50,000 +30,000 70,000 = 0.14

70,000

14 percentreduction in total cost if boththe products will be produced.

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Cost and Revenue Analysis