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    Theory of Cost and Profit

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    Faisal C. Livara
    This document discusses key concepts in cost and profit theory. It defines different types of costs like fixed costs, variable costs, and opportunity costs. It presents cost-output relationships in the short run through total, average, and marginal cost functions. It also discusses revenue concepts like total, average, and marginal revenue. Finally, it explains how firms can maximize profit by producing at the quantity where marginal revenue equals marginal cost.

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    Theory of Cost and Profit

    Uploaded by

    Faisal C. Livara
    64 views25 pages
    This document discusses key concepts in cost and profit theory. It defines different types of costs like fixed costs, variable costs, and opportunity costs. It presents cost-output relationships in the short run through total, average, and marginal cost functions. It also discusses revenue concepts like total, average, and marginal revenue. Finally, it explains how firms can maximize profit by producing at the quantity where marginal revenue equals marginal cost.

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    This document discusses key concepts in cost and profit theory. It defines different types of costs like fixed costs, variable costs, and opportunity costs. It presents cost-output relationships in the short run through total, average, and marginal cost functions. It also discusses revenue concepts like total, average, and marginal revenue. Finally, it explains how firms can maximize profit by producing at the quantity where marginal revenue equals marginal cost.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    64 views25 pages

    Theory of Cost and Profit

    Uploaded by

    Faisal C. Livara
    This document discusses key concepts in cost and profit theory. It defines different types of costs like fixed costs, variable costs, and opportunity costs. It presents cost-output relationships in the short run through total, average, and marginal cost functions. It also discusses revenue concepts like total, average, and marginal revenue. Finally, it explains how firms can maximize profit by producing at the quantity where marginal revenue equals marginal cost.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 25

    THEORY OF COST AND

    PROFIT
    COST CONCEPT
    - a firm maintains a stock of assets that it can use for
    production.

    TWO CLASSIFICATIONS OF ASSETS


    1. Real Assets machineries, buildings, materials and
    supplies.
    2. Monetary Assets forms of money and near
    money, part of which the firm transforms into real
    assets through purchases or acquisitions.
    OPPORTUNITY COST
    Is the foregone opportunity of choosing an
    alternative. The difference between the opportunity
    gained from the alternative and its opportunity cost
    is the net gain (loss) from said choice. Simply put, it
    is how much more (less) one gains in giving up
    alternatives to benefit from a choice.
    IMPUTED COST
    Cost that is implied but not included in financial report
    or accounting record.
    Examples:
    Imputed salary of the entrepreneur who doubles as the
    general manager of the business.
    Imputed rent for the use of personal properties for
    production.
    Interest income for opportunity of using owners money.
    COST-OUTPUT RELATIONSHIP IN
    SHORT RUN
    Certain level of optimum input and maximum
    output, cost-output relationship assumes
    different forms. These are the short-run cost
    functions since plant size and capacity are
    fixed.
    FIXED AND VARIABLE COST
    Total Cost (TC) has two basic components namely: fixed cost and
    variable cost.
    Total Fixed Cost (TFC) does not vary with output; whereus, total
    variable cost (TVC) varies in direct proportion. The following
    equation illustrates:
    TC = TFC + TVC
    Where:
    TC = Total Cost
    TFC = Total Fixed Cost
    TVC = Total Variable Cost
    MARGINAL COST
    The
    following are the marginal cost concepts with the equations that
    define them:
    MC = =
    MVC =
    Therefore, MC = MVC since TFC is constant and TVC is the only
    component that causes TC to change.
    Where: MC = Marginal Cost or change in total cost
    MVC = Marginal Variable Cost or change in Total Variable Cost
    Q = Quantity of Output
    = Infinitesimal Change or a unit change that is infinitely small
    TOTAL AND MARGINAL COST FUNCTION

    Therefore:
    AVERAGE COST
    Average
    cost is the cost per unit of output which assumes the
    following term:

    Where: ATC = Average Total Cost or cost per unit of output


    TC = Total Cost
    Q = Quantity of Output
    AFC = Average Fixed Cost or fixed cost per unit of output
    TFC = Total Fixed Cost
    AVC = Average Variable Cost or variable cost per unit of output
    TVC = Total Variable Cost
    THE AVERAGE COST FUNCTION
    PROFIT CONCEPT

    TOTAL
    AND MARGINAL REVENUES

    The following are the concepts of revenue-output relationship with


    the equations that define them:
    TR = PQ
    (whether price is constant or not)
    M
    M
    M
    where: TR = Total Revenue
    AR = Average Revenue or revenue per unit of output
    MR = Marginal Revenue or revenue per additional unit of output
    P = Price
    Q = Quantity
    = Infinitesimal change
    MAXIMUM PROFIT AND MARGINAL
    APPROACH
    Profit is defined as Total revenue (TR) less Total Cost (TC) with Total
    Variable Cost (TVC) and Total Fixed Cost (TFC) as the latters
    components. The profit function is alternately expressed as follows:
    Profit = TR (TFC + TVC)
    = (TR - TVC) TFC
    Since TR and TVC are the sums of their marginal values (MR and MC)
    and TFC is fixed, the profit function is further expressed as follows:
    Profit = (MR-MC)+TFC
    = (MR-MC)-TFC
    THE MR AND MC CURVES
    PRICE AND NUMBER OF
    SELLERS
    The volume that a seller is willing to
    sell at a certain price level is his
    maximum profit output or supply.
    PRICE CHANGE AND MAXIMUM PROFIT
    PRODUCTIVITY AND TECHNOLOGY
    An increase/decrease in the overall productivity
    level due to technological changes expands/ limits
    productivity capacity. This is due to an
    increase/decrease in the capacity to produce per
    unit of input as reflected in the marginal and
    average product.
    THE MAXIMUM PROFIT POINT
    COST OF
    PRODUCTION
    An increase in the prices of variable inputs
    increases the mc, TVC, AVC and ATC. This
    increase in cost is not associated with plant
    expansion and therefore cost changes but not
    maximum output.
    SHUTDOWN PRICE

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