COST AND REVENUE ANALYSIS of production.

CH APTER : 6 COST AND REVENUE ANALYSIS of production.

Topic wise summary. Meaning and concept of cost. Average cost Types of cost. Explicit cost Implicit cost Real cost Types of explicit cost. Total cost Fixed cost Variable cost Marginal cost Average cost Average total cost Average fixed cost Average variable cost Meaning and concept of revenue, marginal revenue and total revenue.

Meaning and concept of cost. Meaning. The concept of cost is much familiar and important in economics, which was introduced by Wallace, a British economist. In the words of Wallace, by cost of production “is meant the total sum of money required for the production of specific quantity of output, or in other words, cost refers to all the payment and expenses which are necessary to obtain the factors of production, land, labour, capital and management required to produce a commodity.

Following are Elements of Cost Purchase of raw material Purchase of machinery Installation of plant Wages Rent of building Interest of capital Advertisements Payments of taxes Insurance

Prof. Mead Prof. Mead in his book “Economic analysis and policy” has classified cost in to three main sections Production cost Selling cost Sundry cost

Production cost It includes It includes Material costs Interest Wages, Rent, It includes

Selling cost Transportation cost Marketing Cost Selling Cost

Sundry Cost Insurance Cost Payment of Tax Others Charges

Types of production cost. Explicit cost Implicit cost Real cost

Meaning and Explanation. Explicit cost. Explicit cost is also known as money cost or accounting cost. Explicit cost represent all such expenditure incurred by an entrepreneur to pay for getting and hiring the services of factors of production. In other words, all the expenses which are made out of producer's pocket on producing a particular commodity is known as explicit cost, such as wages and salary payments, expenses on the purchase of raw material, light, fuel, transportation, rent on land, interest on capital in terms of loan, taxes and depreciation charges etc.

Implicit cost. Meaning. Implicit cost is the imputed value of the entrepreneur's own resources and services. Implicit cost can be defined as those expenses which an entrepreneur does not have to pay out of his own pocket but these are the cost to the firm. For example, if a person is working in his own firm as a manager, or has invested his own capital or has built the factory on his own land, the reward of all these factors of production are equal to the market price and will be subtracted from producer's profit to find net profit. Thus implicit cost refers to the expenses of producers own resources which are not paid but are excluded as a cost from producer's profit.

Real cost. Meaning. Real cost refers to the pain and inconveniences experienced by labor to produce a particular commodity. Real cost are not taken in money terms, it shows only sacrifices, pain and some sort of inconveniences faced by producers and labor.

Types of explicit cost. Explicit cost consist of the following types. Fixed cost Variable cost Total cost and Marginal cost

Meaning and explanation of each cost Fixed cost. All kinds of expenses which do not vary with rate of production or which do not depend on level of production, are known as fixed cost. Such cost is to be incurred even at the zero level of production or whatever the production level is but such cost is to be bearded by producer. For example, if a producer wishes to establish a shoe factory, he has to meet certain expenses right from the very beginning , such as the cost of machinery, rent of the building, interest on capital, property tax etc. all these expenditures are known as fixed cost.

Variable cost. Meaning. Variable cost are costs whose volume varies with the rate of production. Variable cost increases as the output rate of a firm increases and decreases as the firm's output rate decreases. For instance, the larger the output of shoe factory, the larger will be the payment for labor, material, fuel, power, transportation services etc.

Total cost. Meaning. Total cost is the sum total of total fixed cost and total variable cost at each level of output. Mathematically total cost is given as TC = TFC + TVC

Table of Cost Output Fixed cost Variable cost Total cost Average. Cost 1000 -__ 1 60 1060 2 100 1100 550 3 150 1150 383.333 4 200 1200 300 5 400 1400 280 6 700 1700 283.333 7 2100 8

Marginal cost Meaning. MC is an increase in total cost that results from one unit increase in output. It is defined as “ the cost that results from a one unit change in the production rate”. If for example, the total cost of producing one pen is 8 dollars and the total cost of producing two pens is 15, then the MC of expending output by one unit is 7 dollars only, ( 15 - 8 = 7 ). Mathematically it can be written as MC = ∆ TC ∆ Q

Average cost. Meaning. The entrepreneurs are no doubt interested in the total cost, but they are equally concerned in knowing the cost per unit of product. Per unit cost of production is referred as average cost. The unit cost figures can be derived from the total fixed cost, total variable cost and total cost by dividing ach of them with corresponding output.

Average fixed cost. Meaning. Average fixed refers to fixed cost per unit of output. AFC is found out by dividing the total fixed cost by total output. AFC = For example, if the TFC of shoes factory is 5000 dollars and it produces 500 pairs of shoes, then the AFC is equal to 10 dollars per unit. If it produces 1,000 pairs of shoes, the AFC is the 5 dollars per pair, and if total output is 5000 pairs of shoes, then AFC is 1 dollar per pair of shoes. From the above example, it is clear, that the fixed cost 5000 dollars remains same while AFC decreases as much as the total output or quantity increases. TFC TQ

Average variable cost. Meaning. Average variable cost refers to the variable expenses per unit of output. AVC is obtained by dividing the total variable cost by the total output. For instance, the TVC for producing 100 meters of cloth is 800 dollars, the AVC will be 8 dollars per meter. Mathematically it can be written as AVC = TVC TQ

inam khan RIHS Kabul Average total cost. Meaning. Average total cost refers to cost ( both fixed and variable) per unit of output. ATC is obtained by dividing the TC by the total number of commodities produced by the firm or when the total sum of AFC and AVC is added together, it becomes equal to ATC. Thus, ATC = or ATC = AFC + AVC TC TQ

Diagramme shows relationship

ECONOMIC COSTS Profits to an Profits to an Accountant Economist L R E V N U Economic Profit Accounting Profit Implicit costs (including a normal profit) Economic (opportunity) Costs Explicit Costs Accounting costs (explicit costs only)

Meaning and concept of revenue. Meaning. Like cost, revenue has also very essential role in a certain type of business. Here now the discussion will centre round the various types of revenues of a firm. By revenue of a firm is meant the total sale proceeds or the total money receipts of a firm from the sale of the output. The concept of revenue will be more cleared in various types of revenue.

Types of revenue. There are three major important types of revenue, which are given as under. Total revenue Marginal revenue Average revenue. The above given types are now explained in brief one by one.

Total revenue. Meaning. By total revenue of a firm is meant the total amount of sale proceeds or the total money receipts of the firm. If a firm producing cloth and selling 100 meters of cloth in the market at the price of 40 Afs per meter, the sale proceeds or total money receipts will be 4000 Afs. This total sale proceeds which a firm has received by selling 100 meters of cloth is called its total revenue. The total revenue varies with the sales of a firm. TR = P x Q

Marginal revenue. Meaning. MR is the addition made to the total revenue by a one unit increase in the volume of sales by the firm in the market. For example, if a firm sells 100 meters of cloth at the price of 40 Afs per meter the TR of the firm is 4000 Afs. If it increase the volume of sale from 100 meters to 101 meters, by one meter increase, the TR of the firm goes up to 4040. this addition of 40 Afs to the TR of 4000 Afs, by a one unit increase in sale is known as MR of the firm. Mathematically it can be written as MR = ∆ TR q∆

Average revenue. Meaning. AR is revenue which is received per unit of output. Average revenue is obtained by dividing the total revenue by the total number of units sold in the market. If for example, a firm sells 200 meters of cloth for 600 Afs, then the average revenue will be 3 Afs. AR represents average sale price per unit of the product or output. Mathematically it can be written as AR = TR TQ

Revenue Schedule Units Price/unit Total .R M.R Avearge.R 10 5 50 - 11 55 12 60 13 65 14 70 15 75 16 80