Revenue and Cost of Production PDF

Revenue and the Cost of SALES REVENUE Increase Net Profit By Revenue Costs People are to Incentives while Businesses are to Profit Adam Smith (Wealth of Nations book): “It is not from the benevolence of the butcher, the brewer, or the baker that we...

Revenue and the Cost of SALES REVENUE Increase Net Profit By Revenue Costs People are to Incentives while Businesses are to Profit Adam Smith (Wealth of Nations book): “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard of their own interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our necessities, but of their advantage.”  Bus ines sm an What is Income ? What Eco is Cost? no Accou mis ntant t Learning Objectives At the end of this lesson, the student should be able to: 1. Differentiate the types of income and the types of cost in production; 2. Determine what considerations should be made by individuals in making business decisions; and 3. Discuss situations that may affect businesses’ production and cost. Total Revenue = Price x Quantity Quantit Pric Total Relationship of Quantity y e Revenu to Total Revenue (unit) per e 1200 Unit (in Total Revenue 1000 Pesos) 800 2 100 200 600 4 100 400 400 6 100 600 200 8 100 800 0 2 4 6 8 10 10 100 1,000 Quantity How to compute for income? Accounting Income = Total Revenue – Total Cost How to compute for income? Accounting Income = Total Revenue – Total Cost Accounting Profit = Total Revenue – Explicit Cost Economic Profit = Total Revenue – [Explicit Cost + Implicit Cost]  Total Opportuni “Actual ty Cost ” Costs Economic Profit = Total Revenue – [Explicit Cost + Implicit Cost] Opportunity Cost: the value of something is what you give up to get it Is Opportunity Cost a cost?  Bus ines sm Economic Accounting Profit an Profit = Total Revenue – = Total Revenue What is [Explicit Cost – Explicit Cost Income ? What Eco + Implicit is Cost? no Cost] Accou mis ntant t  Accounting Profit vs Economic Profit Total Revenue Explicit Cost Accounting Profit (Php 10,000.00 x 10 (Php 1,500.00 x 10 (Total Revenue – Explicit units) units) Cost) Php 100,000.00 Php 15,000.00 Php 85,000.00 Total Explicit Cost Implicit Cost Economic Revenue (Php 1,500.00 x Profit (Php 10,000.00 10 units) (Total Revenue – x 10 units) [Explicit Cost + Implicit Cost) Php 15,000.00 Php 18,000.00 Php Php Accounting Profit vs Economic Profit How Accountants View Profit Explicit Cost Accounting Profit How Economists View Profit Explicit Cost Implicit Economic Profit Cost  Accounting Profit vs Economic Profit Total Revenue Explicit Cost Accounting Profit (Php 5,000.00 x 10%) (Php 5,000.00 x 1%) (Total Revenue – Explicit Cost) Php 500.00 Php 50.00 Php 450.00 Total Explicit Cost Implicit Cost Economic Revenue (Php 5,000.00 x (Php 5,000.00 x Profit (Php 5,000.00 x 1%) (15%-10%)) (Total Revenue – 10%) [Explicit Cost + Implicit Cost) Php 250.00 Php 500.00 Php 50.00 Php 200.00 Two Functions of Price: Rationing and Allocative Price & Two Functions of Price Rationing Function of Rationing Function of Price is like distributing Price is the changes in resources (which are price attributed to the scarce) equitably. distribution of resources to consumers who need them the most (Frank & Bernanke, 2013). Two Functions of Price Allocative Function of Allocative Function of Price can be related to Price is the changes in the concept of prices that direct utilitarianism. resources away from overcrowded markets and toward markets that are underserved (Frank & Bernanke, 2013). Production Production Function It shows the relationship between quantity of inputs used to create a good and the quantity of output produced.  Production Function Table. Production Output of the Bakers at Baked by Chris Bakers Output / Marginal Rent on Cost for Total Product Product the the Cost s Shop Bakers Produce d Production 0 0 100 0 100 Function 1 50 50 100 20 120 2 90 40 100 40 140 3 120 30 100 60 160 4 140 20 100 80 180 Production Function Production Output of Bakers at Baked by Chris 160 Output / Products 140 120 Produced 100 80 60 40 20 0 0 1 2 3 4 5 Bakers  Marginal Product is the change (increase or Production Function decrease) in output from one additional unit of input. Table. Production Output of the Bakers at Baked by Chris Bakers Output / Marginal Rent on Cost for Total Product Product the the Cost s Shop Bakers Produce d 90 – 50 = 40 0 0 100 0 100 1 50 50 100 20 120 2 90 40 100 40 140 3 120 30 100 60 160 4 140 20 100 80 180 Marginal Product Concept Explained BAKERY A BAKERY B One Baker Five Bakers Demand = 100 pieces/ Demand = 100 pieces/ type type One Baker : 100 pieces One Baker : 20 pieces Will try to meet demand Many types of bread – to earn profit pandesal, ensaymada, pan de coco, spanish bread, and monay Law of Diminishing Marginal Product The Law of Diminishing Marginal Product The Law of Diminishing Marginal Product is the scenario where the marginal product of an input decreases as the quantity of the input increases. This scenario might exist if the demand is constant, or all equipment are the same.  4th Column = Fixed Cost 5th Column = Variable Production Function Cost 6th Column = Total Cost Table. Production Output of the Bakers at Baked by Chris Bakers Output / Marginal Rent on Cost for Total Product Product the the Cost s Shop Bakers Produce d 0 0 Costs of Production 100 0 100 1 50 50 100 20 120 2 90 40 100 40 140 3 120 30 100 60 160 4 140 20 100 80 180 Type of Cost Fixed Costs (FC) are costs that do not vary with the quantity produced. Examples are monthly rent, and insurance payments. Variable Costs (VC) are costs that vary with the quantity produced. Examples are raw materials, and cost for laborers. Total Cost (TC) is the combination of fixed costs and variable costs. Formula is TC = FC + VC.  Average Costs are also Other Measures of Cost called per-unit cost Average Fixed Costs (AFC) = Fixed Cost/Quantity or FC/Q Average Variable Costs (AVC) = Variable Cost/Quantity or VC/Q Average Total Cost (ATC) = Total Cost/Quantity or TC/Q or AFC+AVC Marginal Cost (MC) is the increase in total cost (TC) from an additional unit of production. It can also be  Table. Cost of Production of Jotik’s Funeral Parlor Quantity Fixed Variable Total Cost Average Average Average Marginal of urns Cost Cost Fixed Variable Total Cost Cost made per (VC) Cost Cost (ATC) (MC) day (FC) (TC) (AFC) (AVC) 0 300 0 300 - - - - 1 300 30 330 300 30 330 30 2 300 80 380 150 40 190 50 3 300 150 450 100 50 150 70 4 300 240 540 75 60 135 90 5 300 350 650 60 70 130 110 6 300 480 780 50 80 130 130 7 300 630 930 43 90 133 150 8 300 800 1,100 38 100 138 170 9 300 990 1,290 33 110 143 190 10 300 1,200 1,500 30 120 150 210 AFC = FC / Q  FC is unchanging while Q is increasing AFC decreases as quantity produced increases. Other Measures of Cost Average Fixed Cost of Jotik’s Funeral Parlor 350 Average Fixed Cost 300 250 200 150 100 50 0 0 1 2 3 4 5 6 7 8 9 10 Quantity of Urns Produced Per Day  Table. Cost of Production of Jotik’s Funeral Parlor Quantity Fixed Variable Total Cost Average Average Average Marginal of urns Cost Cost Fixed Variable Total Cost Cost made per (VC) Cost Cost (ATC) (MC) day (FC) (TC) (AFC) (AVC) 0 300 0 300 - - - - 1 300 30 330 300 30 330 30 2 300 80 380 150 40 190 50 3 300 150 450 100 50 150 70 4 300 240 540 75 60 135 90 5 300 350 650 60 70 130 110 6 300 480 780 50 80 130 130 7 300 630 930 43 90 133 150 8 300 800 1,100 38 100 138 170 9 300 990 1,290 33 110 143 190 10 300 1,200 1,500 30 120 150 210 AVC = VC / Q  VC is increasing as well as Q is increasing AVC increases as VC increases. Other Measures of Cost Average Variable Cost of Jotik’s Funeral Parlor 140 Average Variable 120 100 80 Cost 60 40 20 0 0 1 2 3 4 5 6 7 8 9 10 Quantity of Urns Produced Per Day  Table. Cost of Production of Jotik’s Funeral Parlor Quantity Fixed Variable Total Cost Average Average Average Marginal of urns Cost Cost Fixed Variable Total Cost Cost made per (VC) Cost Cost (ATC) (MC) day (FC) (TC) (AFC) (AVC) 0 300 0 300 - - - - 1 300 30 330 300 30 330 30 2 300 80 380 150 40 190 50 3 300 150 450 100 50 150 70 4 300 240 540 75 60 135 90 5 300 350 650 60 70 130 110 6 300 480 780 50 80 130 130 7 300 630 930 43 90 133 150 8 300 800 1,100 38 100 138 170 9 300 990 1,290 33 110 143 190 10 300 1,200 1,500 30 120 150 210 C = TC / Q or AFC + AVC  AVC is increasing, hence, ATC is also incre C increases as AVC increases.  Efficient Scale Output* Other Measures of Cost *Not known yet if cost will also be minimized Average Total Cost of Jotik’s Funeral Parlor 350 Average Total Cost 300 250 200 150 100 50 0 0 1 2 3 4 5 6 7 8 9 10 Quantity of Urns Produced Per Day How can we say that the lowest point is the efficient scale output? (ATC = TC/Q) Scenario 1 (FIRM A) Scenario 2 (FIRM B) TC = P1,000,000.00 TC = P1,000,000.00 Q = 10 units Q = 1,000 units ATC = TC/Q = ATC = TC/Q = 1,000,000/10 = 100,000 1,000,000/1,000 = 1,000 Firm B is more efficient because given the same budget, it was able to produce more. It also has a lower ATC.  Efficient Scale Output* Other Measures of Cost *Not known yet if cost will also be minimized Average Total Cost of Jotik’s Funeral Parlor 350 Average Total Cost 300 250 200 150 Low Level 100 Output, 50 ATC is 0 high 0 1 2 3 4 5 6 7 8 9 10 Quantity of Urns Produced Per Day  Table. Cost of Production of Jotik’s Funeral Parlor Quantity Fixed Variable Total Cost Average Average Average Marginal of urns Cost Cost Fixed Variable Total Cost Cost made per (VC) Cost Cost (ATC) (MC) day (FC) (TC) (AFC) (AVC) 0 300 0 300 - - - - 1 300 30 330 300 30 330 30 2 300 80 380 150 40 190 50 3 300 150 450 100 50 150 70 4 300 240 540 75 60 135 90 5 300 350 650 60 70 130 110 6 300 480 780 50 80 130 130 7 300 630 930 43 90 133 150 8 300 800 1,100 38 100 138 170 9 300 990 1,290 33 110 143 190 10 300 1,200 1,500 30 120 150 210 Marginal Cost (MC) is the change in total cost (TC) from an additional unit of production.  Point where MC crosses the ATC Other Measures of Cost curve = efficient scale (the quantity that Cost of Production of Jotik’s Funeral Parlorminimizes ATC) 350 Costs 300 250 afc 200 avc 150 atc mc 100 50 0 0 1 2 3 4 5 6 7 8 9 10 Quantity of Urns Produced Per Day Efficient Scale is the quantity that minimizes ATC. How can this statement be If this is the case, we can correct? also conclude: 1. It is at the lowest point of the ATC. This is said to be 1. Whenever MC is below the efficient scale output. ATC, ATC must be decreasing; and 2. If the additional cost (MC) of a certain point in the production is equal to the 2. Whenever MC is greater overall cost per product of than ATC, ATC must be the firm (ATC), it is like increasing. spending every additional unit at an equal level where Are the costs likely to change? YES, this usually happens at a certain period. Example, rent (fixed cost) can increase after a year or more. In the long run, fixed costs will already become variable costs. The Long-Run Average Total Cost (LRATC) is derived from different Short-Run Average Total Cost (SRATC). Long-Run Average Total Cost (LRATC)  Long-Run Average Total Cost (LRATC) Part I – 1:2 Economies of Scale refers to the state where LRATC falls as the quantity of output, as well as input, increases. The ideal point for firms to expand their business or production because they know that they are already efficient at their production.  Long-Run Average Total Cost (LRATC) Part II – 1:1 Constant Returns to Scale refers to the state where LRATC stays the same as the quantity of output increases. This means that increasing quantity will lead to the same amount of cost.  Long-Run Average Total Cost (LRATC) Part III – Diseconomies of Scale refers to the state where LRATC rises as the quantity of output increases. This is the least ideal part because the higher ATC means less productions, but more input.