2.1] Revenue concept

Revenue is the total amount of money that a company generates from the sale of its goods or services. It is also known as sales or income. Revenue is the top line item on a company’s income statement, and it is used to calculate net income, which is the bottom line.

Total revenue

Total revenue is the total amount of money that a company earns from all of its sales over a period of time. It is calculated by multiplying the quantity of goods or services sold by the price per unit.

Formula:

Total revenue = Quantity sold * Price per unit

Example:

A company sells 100 widgets for $10 each. Its total revenue for the period would be $1,000.

Average revenue

Average revenue is the total revenue divided by the quantity sold. It is a measure of how much money a company earns per unit of sales.

Formula:

Average revenue = Total revenue / Quantity sold

Example:

In the above example, the company’s average revenue is $10 per widget.

Marginal revenue

Marginal revenue is the additional revenue that a company generates from selling one more unit of output. It is calculated by taking the difference in total revenue between selling one more unit and selling one fewer unit.

Formula:

Marginal revenue = Change in total revenue / Change in quantity sold

Example:

If the company sells 101 widgets instead of 100 widgets, its total revenue increases from $1,000 to $1,100. Therefore, the marginal revenue from selling one more widget is $100.

Relationship between total revenue, average revenue, and marginal revenue

Total revenue, average revenue, and marginal revenue are all related to each other. Total revenue is equal to average revenue multiplied by quantity sold. Marginal revenue is equal to the change in total revenue divided by the change in quantity sold.

In general, as a company sells more units of output, its total revenue increases. However, its average revenue and marginal revenue may not increase at the same rate. In fact, average revenue and marginal revenue may even decrease as a company sells more units of output.

This is because companies often have to offer discounts or other incentives to customers in order to sell more units. As a result, the average price that a company receives per unit may decrease as it sells more units. Additionally, the cost of producing additional units of output may increase as a company approaches capacity. As a result, the marginal revenue from selling one more unit may decrease as a company sells more units.

Conclusion

Total revenue, average revenue, and marginal revenue are important concepts in economics and business. By understanding these concepts, companies can make better decisions about pricing, production, and marketing.

2.2] Behavior of Revenue curves under perfect and imperfect competition

Revenue curves under perfect competition

In a perfectly competitive market, there are many buyers and sellers of identical goods or services. Each firm has a negligible share of the market and cannot influence the market price. Therefore, firms in perfect competition are price takers.

The revenue curve for a perfectly competitive firm is a horizontal line parallel to the x-axis. This means that the firm can sell as much of its output as it wants at the prevailing market price. The firm’s average revenue (AR) and marginal revenue (MR) are equal to the market price.

Revenue curves under imperfect competition

In an imperfectly competitive market, there are fewer sellers than in a perfectly competitive market, and sellers may have some degree of control over the price of their goods or services. Imperfect competition can take many forms, such as monopoly, monopolistic competition, and oligopoly.

The revenue curve for an imperfectly competitive firm will typically slope downwards, meaning that the firm must lower its price in order to sell more output. This is because imperfectly competitive firms face a demand curve that is downward sloping. The firm’s AR and MR curves will also slope downwards, but the MR curve will typically lie below the AR curve.

The following graph shows the revenue curves for perfectly and imperfectly competitive firms:

The horizontal line represents the revenue curve for a perfectly competitive firm. The downward sloping line represents the revenue curve for an imperfectly competitive firm.

Differences in revenue curves under perfect and imperfect competition

The following table summarizes the key differences in revenue curves under perfect and imperfect competition:

Characteristic	Perfect competition	Imperfect competition
Slope of revenue curve	Horizontal	Downward sloping
Relationship between AR and MR	AR = MR	MR < AR
Ability to influence market price	No	Yes

Implications of different revenue curves

The different shapes of the revenue curves under perfect and imperfect competition have important implications for firms’ pricing and output decisions.

Perfectly competitive firms cannot influence the market price, so they produce at the output level where MR = MC. This is the profit-maximizing output level for a perfectly competitive firm.

Imperfectly competitive firms can influence the market price, so they face a trade-off between producing more output and charging a higher price. Firms will typically produce at the output level where MR = MC, but they will charge a higher price than perfectly competitive firms.

The higher price charged by imperfectly competitive firms means that they will earn higher profits than perfectly competitive firms. However, imperfectly competitive firms also face the risk of losing market share to their competitors if they charge too high a price.

2.3] Meaning and Types of Cost

Meaning of cost

Cost is the amount of money that is spent to produce a product or service. It is the monetary value of the resources that are used up in the production process. Costs can be incurred in a variety of ways, such as through the purchase of raw materials, the payment of wages and salaries, and the rental of equipment.

Types of cost

There are many different ways to classify costs. Some of the most common classifications include:

• Fixed costs: Fixed costs are costs that remain the same regardless of the level of production. Examples of fixed costs include rent, insurance, and salaries.
• Variable costs: Variable costs are costs that change in proportion to the level of production. Examples of variable costs include the cost of raw materials and direct labor.
• Semi-variable costs: Semi-variable costs are costs that have a fixed and variable component. Examples of semi-variable costs include utilities and maintenance costs.
• Direct costs: Direct costs are costs that can be directly traced to a specific product or service. Examples of direct costs include the cost of raw materials and direct labor.
• Indirect costs: Indirect costs are costs that cannot be directly traced to a specific product or service. Examples of indirect costs include rent, insurance, and administrative costs.
• Opportunity costs: Opportunity costs are the costs of the next best alternative that is given up when a decision is made. For example, if a company decides to build a new factory, the opportunity cost is the profit that could have been earned by investing the money in another way.
• Sunk costs: Sunk costs are costs that have already been incurred and cannot be recovered. For example, if a company spends money to develop a new product that is unsuccessful, the development costs are sunk costs.

Importance of cost accounting

Cost accounting is the process of tracking, analyzing, and reporting on costs. It is an important tool for businesses of all sizes because it helps them to:

• Make informed decisions about pricing, production, and investment.
• Improve efficiency and reduce costs.
• Identify and track profitability.
• Comply with tax and regulatory requirements.

Conclusion

Cost is a fundamental concept in business. By understanding the different types of costs and how to track and analyze them, businesses can make better decisions that will lead to improved profitability.

2.4] Behavior of Cost curves in short run and long run

Short Run

The short run is a period of time in which at least one factor of production is fixed. This means that the firm cannot change the quantity of this factor in response to changes in demand or output. Fixed costs are costs that do not change with the level of output, such as rent on a factory or the salary of a manager. Variable costs are costs that do change with the level of output, such as the cost of raw materials or the wages of hourly workers.

The short-run cost curves include:

• Total cost (TC): The total cost of producing a given level of output. TC is the sum of fixed costs (FC) and variable costs (VC).
• Average fixed cost (AFC): The total fixed cost divided by the level of output. AFC decreases as the level of output increases.
• Average variable cost (AVC): The total variable cost divided by the level of output. AVC typically decreases at first as the level of output increases, but it eventually starts to increase due to diminishing marginal returns.
• Average total cost (ATC): The total cost of producing a given level of output divided by the level of output. ATC is the sum of AFC and AVC.
• Marginal cost (MC): The change in total cost that results from producing one additional unit of output. MC is typically equal to AVC in the short run.

The short-run average total cost curve (ATC) is U-shaped, as shown in the following graph:

[Graph of a short-run ATC curve]

The ATC curve initially decreases because the AFC curve is decreasing and the AVC curve is also decreasing. However, the AVC curve eventually starts to increase, which causes the ATC curve to increase as well. The minimum point on the ATC curve is the point at which the firm’s average total cost is minimized. This point is also known as the firm’s profit-maximizing output level.

Long Run

The long run is a period of time in which all factors of production are variable. This means that the firm can change the quantity of all factors of production in response to changes in demand or output.

The long-run cost curves include:

• Long-run total cost (LTC): The minimum total cost of producing a given level of output in the long run. LTC is the envelope of all the short-run ATC curves.
• Long-run average total cost (LRAC): The minimum average total cost of producing a given level of output in the long run. LRAC is equal to LTC divided by the level of output.

The long-run average total cost curve (LRAC) is typically U-shaped, but it can also be L-shaped or horizontal. The shape of the LRAC curve depends on the firm’s technology and the degree of economies of scale in its production process.

Economies of scale are reductions in the average total cost of production that occur as the firm increases its output level. For example, a firm may be able to negotiate lower prices for raw materials or invest in more efficient production equipment as it produces a larger volume of output.

If a firm experiences economies of scale, its LRAC curve will be U-shaped. This is because the firm’s average total cost will decrease as it increases its output level. However, the firm’s average total cost will eventually start to increase due to diminishing marginal returns.

If a firm does not experience economies of scale, its LRAC curve will be either L-shaped or horizontal. This is because the firm’s average total cost will remain constant or increase as it increases its output level.

Conclusion

The behavior of cost curves in the short run and long run is different because of the difference in the ability of firms to change their inputs. In the short run, at least one factor of production is fixed, which limits the firm’s flexibility. In the long run, all factors of production are variable, which gives the firm more flexibility to adjust its inputs and costs in response to changes in demand or output.

2.5] Types of Profit

There are two main types of profit: accounting profit and economic profit.

Accounting profit is the profit that a company shows on its income statement after subtracting all explicit costs, such as wages, rent, and depreciation. It is also known as net income. Accounting profit is the most common type of profit reported by companies, and it is used by investors and creditors to assess a company’s financial performance.

Economic profit is a more comprehensive measure of profitability that takes into account both explicit and implicit costs. Implicit costs are the opportunity costs of using a company’s resources. For example, the implicit cost of using the owner’s capital in the business is the return that the owner could have earned by investing that money in another way.

To calculate economic profit, you subtract all explicit and implicit costs from revenue. This gives you a measure of how much profit the company is generating above and beyond what it could have earned by using its resources in other ways.

Here is a table that summarizes the key differences between accounting profit and economic profit:

Characteristic	Accounting profit	Economic profit
Explicit costs	Yes	Yes
Implicit costs	No	Yes
Reported on financial statements	Yes	No
Used by investors and creditors	Yes	No
Used by management for decision-making	No	Yes

Here is an example of how to calculate accounting profit and economic profit:

Company A

• Revenue: $100,000
• Explicit costs: $75,000
• Implicit costs: $10,000

Accounting profit:

$100,000 – $75,000 = $25,000

Economic profit:

$100,000 – $75,000 – $10,000 = $15,000

As you can see, economic profit is lower than accounting profit because it takes into account the opportunity cost of the company’s resources.

Economic profit is a more useful measure of profitability for management decision-making. It can be used to assess whether a particular investment or project is profitable, and it can also be used to compare the profitability of different companies.