5 Key excerpts on "Cost and Revenue"

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  eBook - ePub

  Economics for Investment Decision Makers

  Micro, Macro, and International Economics

  • Christopher D. Piros, Jerald E. Pinto(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  theory of the firm , the subject of this chapter, is the study of the supply of goods and services by profit-maximizing firms. Conceptually, profit is the difference between revenue and costs. Revenue is a function of selling price and quantity sold, which are determined by the demand and supply behavior in the markets into which the firm sells or provides its goods or services. Costs are a function of the demand and supply interactions in resource markets, such as markets for labor and for physical inputs. The main focus of this chapter is the cost side of the profit equation for companies competing in market economies under perfect competition. The next chapter examines the different types of markets into which a firm may sell its output.

  The study of the profit-maximizing firm in a single time period is the essential starting point for the analysis of the economics of corporate decision making. Furthermore, with the attention given to earnings by market participants, the insights gained by this study should be practically relevant. Among the questions this chapter will address are the following:

  • How should profit be defined from the perspective of suppliers of capital to the firm?
  • What is meant by factors of production?
  • How are total, average, and marginal costs distinguished, and how is each related to the firm’s profit?
  • What roles do marginal quantities (selling prices and costs) play in optimization?

  This chapter is organized as follows: Section 2 discusses the types of profit measures, including what they have in common, how they differ, and their uses and definitions. Section 3 covers the revenue and cost inputs of the profit equation and the related topics of breakeven analysis, shutdown point of operation, market entry and exit, cost structures, and scale effects. In addition, the economic outcomes related to a firm’s optimal supply behavior over the short run and the long run are presented in this section. A summary and practice problems conclude the chapter.

  2. OBJECTIVES OF THE FIRM

  This chapter assumes that the objective of the firm is to maximize profit over the period ahead. Such analysis provides both tools (e.g., optimization) and concepts (e.g., productivity) that can be adapted to more complex cases, and also provides a set of results that may offer useful approximations in practice. The price at which a given quantity of a good can be bought or sold is assumed to be known with certainty (i.e., the theory of the firm under conditions of certainty). The main contrast of this type of analysis is to the theory of the firm under conditions of uncertainty, where prices, and therefore profit, are uncertain. Under market uncertainty, a range of possible profit outcomes is associated with the firm’s decision to produce a given quantity of goods or services over a specific time period. Such complex theory typically makes simplifying assumptions. When managers of for-profit companies have been surveyed about the objectives of the companies they direct, researchers have often concluded that (1) companies frequently have multiple objectives; (2) objectives can often be classified as focused on profitability (e.g., maximizing profits, increasing market share) or on controlling risk (e.g., survival, stable earnings growth); and (3) managers in different countries may have different emphases.

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  eBook - ePub

  Organisations and the Business Environment

  • Tom Craig, David Campbell(Authors)
  • 2012(Publication Date)
  • Routledge

    (Publisher)

  covering the costs that the business has incurred in bringing the product to the market. Such costs may typically include the cost of the materials in the product, the costs of labour, rent on premises, transport costs, marketing or advertising costs, packaging costs, etc. In this respect, the price charged ensures that the seller does not make a trading loss.

  It is a means of gaining wealth and of making a profit if the price charged includes a net surplus over all costs incurred. Profits are used to reinvest in the business (e.g. buying more equipment) and to pay the owners of the business a return, such as the giving of dividends on shares.

  Profit

  We use the term ‘profit’ in a number of ways in ordinary conversation. In economic terms, the profit is the surplus a business is left with once a price has been achieved in a business transaction and all the costs have been paid.

  It can represent the cash surplus on one business transaction, in which case we express it as:

  profit = price – total cost or π = P – TC.

  It can also represent the total surplus made by a business over a period of time. This would be expressed as:

  profit = total revenue – total cost or π = TR – TC.

  for the time period in question.

  The price can sometimes be a signal to the buyer. A buyer often makes the assumption that ‘you get what you pay for’. In this regard, a low price will communicate certain features of the product to the buyer (e.g. cheap and cheerful, functional, basic, etc.) whereas a high price will have the opposite effect (e.g. quality, premium, luxurious, etc.).

  Revenue

  The term revenue is sometimes referred to as sales value, turnover, or income. It is the total sales for a business over a period of time and is expressed as:

  total revenue = price × quantity sold or TR = P × Q.

  Hence, if the price of a good is £2 and, over the course of a month, the business sells 1000 units, then its revenue for the month is £2 × 1000 = £2000. If sales are consistent over a year, the quantity for the year would be 12,000 and revenue, £24,000.

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  eBook - ePub

  Business Economics

  • Rob Dransfield(Author)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  This chapter introduces you to some simple techniques for analysing the costs and revenues of a business. The approaches employed are based on a combination of approaches used in business and economic analysis with a focus on relevance to real world business decision making. The chapter shows you how to calculate and record different types of costs and revenues incurred and received by businesses. You are shown how to measure and illustrate different types of costs and revenues and methods that can be used to identify break-even, loss making and profit making positions for a business.

  4.2  The nature of cost–volume–profit analysis A business model

  All businesses will receive revenues from selling products. They will incur costs in making and providing these products. The relationship between costs and revenues can be illustrated by taking the example of the giant multinational company BIC. BIC is a company that is able to benefit from what economists refer to as economies of scale. Economies of scale are the cost savings per unit of production that a large firm is able to achieve from producing on a very large scale. For example, BIC is able to spread its marketing costs across billions of units of product that are sold across the globe.

  Key Term

  Business model – a description of the operations of a business, including its plans to increase revenues and control costs.

  For example, BIC is an international business that focuses on producing biros, razors and cigarette lighters among other products. Its core lines are functional in meeting customer needs for standard useful items at value for money prices. BIC’s business model includes maximizing revenues by providing useful goods at attractive prices, and in controlling its costs through efficient operations including exploitation of economies of scale. These economies of scale include mass production and distribution.

  The relationship between revenues and costs determines the profit that a business makes. Key Term

  Revenue – the receipt from selling a good or service.

  There are a number of different ways of measuring revenue which are explored later in this chapter. In the context of this chapter cost will be defined as the money outlay to produce, and/or sell a good. The relationship between costs and revenues can be introduced by the application of cost–volume–profit analysis.

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  eBook - ePub

  Production and Cost Functions

  Specification, Measurement and Applications

  • Erkin Bairam, Erkin Bairam(Authors)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  (8) in the place of a convolution term for a consumed input.

  Economists are aware that cost functions have to be estimated on the basis of sample data in most instances. The convolution terms in(8) are random variables and sample data could be used to estimate their average values along with other parameters of the underlying processes. However the essentially statistical nature of accounting earnings as an estimator of the long term average cost function of the firm and the part played by the depreciation calculation and other accounting allocations does not appear to be well understood at the theoretical level by either accountants or economists. The characteristics of the profitability and cost per unit of time of an activity, a collection of activities or a firm can only be known with certainty and measured directly when the activity is completed or the firm liquidated. One way of interpreting the accounting earnings function, therefore is as a time dependent estimate of this ultimate, direct measure. A two period, one product firm, for example, might buy a machine for $6 and expend a further $4 on input costs in period 1, selling one unit of output for $10 in period 1 and one for $12 in period 2, scrapping the machine at the end of the second period. The lifetime profit of the firm is $(22−4−6) = $12. This was earned over two periods so that the time rate of profitability is $6. This rate is unknown at the end of the first accounting period and standard statistical criteria thus suggests that the best earnings estimate for that period is one which, on average, is closest to $6. As the convolution terms are fixed in the form of(8) the D term is important because it can be manipulated to give the best estimate of the chosen parameter with respect to some statistical criteria. With hindsight and adopting the accounting accrual convention of only recognizing the profit from an activity when it is complete (i.e. sold) D

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  eBook - ePub

  Media Economics

  Applying Economics to New and Traditional Media

  • Colin Hoskins, Stuart M. McFadyen, Adam Finn(Authors)
  • 2004(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  Theory of the Firm . Firms are assumed to maximize profits. Profits are equal to total revenue minus total cost. Thus a firm chooses to produce at the output level or price that maximizes the difference between total revenue and total cost. In the last chapter, we examined how cost varied with output. The first topic we examine in this chapter is how revenue varies with output and price. By bringing together the revenue with the cost side examined in the last chapter, we are able to explore the level of output and price that maximizes profits and the use of marginal analysis in determining these. Incremental analysis and discounting are introduced as managerial techniques firms can use to identify the most profitable option in real-world situations. We examine in detail how the economist measures profit, how this differs from the accountant’s concept of profit, and the implications for decision making by firms. Two managerial decision techniques, incremental analysis and net present value, are explored. The implications of risk for business decisions are considered.

  6.1 Revenue

  We need to distinguish between total revenue, average revenue, and marginal revenue, and examine the relationship between these revenue concepts. We will do this assuming that each unit of output sold is sold at the same price.

  Total revenue (TR) is equal to the quantity (Q) sold of a good or service multiplied by the price (P) at which it is sold:

  TR = Q × P  

  Average revenue (AR) is the revenue per unit of output. It equals total revenue divided by quantity:

  AR = TR/Q  

  But as TR = Q × P, substituting for TR in this equation gives AR = Q × P/Q = P. Hence AR is equal to price. This relationship implies that a firm’s demand curve is also its average revenue curve. The demand curve shows the quantity demanded at any given price. The average revenue curve shows the average revenue, equal to price, for any quantity demanded. Hence a firm’s demand curve often has an AR label attached to it as well as a D.

  Marginal revenue (MR) is the change in total revenue resulting from the output of one more unit of the good or service:

  MR = ΔTR/ΔQ   where ΔTR is the change in total revenue and ΔQ is the (one unit) change in output.

  If the firm can sell the additional unit at an unchanged price, then the demand curve for the firm is horizontal, and marginal revenue equals price. As we will see later, however, this only holds for perfect competition, a very competitive situation in which many companies sell an identical product.

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