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Effect of cost and revenue
Effect of cost and revenue
Vocabulary list:
Learners must first give a description of the following words in their notebook.
MC = Marginal Cost
It is the amount by which the total cost increase when one extra unit of a product is
produced.
∆Total Cost (TC) ÷ ∆ Output (Q) = MC
MR = Marginal Revenue
Marginal revenue refers to the extra amount of revenue earned when an additional (extra)
unit of a product is sold.
∆TR ÷∆ Q = MR
AC = Average Cost
Total Fixed Cost + Total Variable Cost = Total Cost
Total Cost ÷ Total output = AC.
Also called unit cost.
AR = Average Revenue
Average revenue refers to the amount the enterprise earns for every unit sold.
TR ÷ Q = AR
Because TR = PQ,
it follows that AR = PQ ÷ Q
therefore, AR = Price
AVC = Average Variable Cost
Total Variable Cost divided by number of units produced.
Total Variable Cost ÷ Total output = AVC.
P = Price
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A value that will purchase a definite quantity, weight, or other measure of a good or
service.
Q = Quantity
The extent, size, or sum of countable or measurable discrete events, objects, or
phenomenon, expressed as a numerical value.
Specific the idea must be identified and understood and not merely a random idea
Measurable it must be possible to test or measure whether the goal has been reached
Agreed in a small business, the goal is easy to set as the owner is the only one
who has to agree, in a larger business there will be many stakeholders
who need to agree
Realistic the goal must not be out of reach for the business, the business must be
capable of generating the required profit
Time there must be a time limit on achieving the goal
specific
Survival
Profit maximization
Revenue Maximization
Sales Maximization
Short run
It is that period where at least one input is fixed.
The enterprise can increase its outputs by increasing its variable factors.
Long run
It is that period where both fixed factors and variable factors can be changed.
2
Differentiate between long run costs and short run costs.
The main difference between fixed factor and a variable factor is the time it takes to
change the input.
Fixed factors:
These are inputs that take time and planning to increase.
E.g. size of the factory or building, the type of machines that is used, etc.
Variable factors
These are inputs that can be changed easily and quickly.
E.g. electricity, labour, water, etc.
3
Abbreviations used in graphs:
Abbreviations used in
graphs
FC Fixed Cost
VC Variable Cost
TC Total Cost
MR Marginal Revenue
MC Marginal Cost
AC Average Cost
ATC Average Total Cost
AC Average Cost
AVC Average Variable Cost
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AR Average revenue
Output
Output is the quantity of goods produced during a certain period.
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Total Fixed Cost (TFC) / FC
It is all those costs which stay the same, no matter how many products are
produced by the enterprise.
It must be paid, irrespective whether 0 or 1 million units are being produced.
E.g. insurance premiums, rent of the building, property taxes, etc.
Total
Fixe
d Total Tota
Cost Variabl l
Outpu (TFC e Cost Cost
t ) (TVC) (TC)
0 3 0 3
1 3 5 8
2 3 8 11
3 3 10 13
4 3 11.5 14.5
5 3 13 16
6 3 15 18
7 3 18 21
8 3 23 26
9 3 31 34
10 3 43 46
6
As the outputs increase, variable cost will increase.
Total cost of one unit – the total cost for the previous unit.
Total
Variabl Total Marginal
Output e Cost Cost Cost
(Q) (TVC) (TC) (MC)
0 0 3 -
1 5 8 5
2 8 11 3
3 10 13 2
4 11.5 14.5 1.5
5 13 16 1.5
6 15 18 2
7 18 21 3
8 23 26 5
9 31 34 8
10 43 46 12
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It now becomes more expensive to produce each additional unit of a product
Each time when an extra product is produced, it becomes more expensive to
produce each additional unit of the product.
However, even though the marginal cost is rising, the firm can still continue
producing more units of a good as long as the marginal revenue is greater than
the marginal cost.
Take note: The law of diminishing returns is also referred to as the law of diminishing
marginal returns.
AVERAGE COST CURVES
Averag
Averag e
Outpu e Fixed Variable Averag
t Cost cost e Cost
AFC + AVC = AC
0
1 3 5 8
2 1.5 4 5.5
3 1 3.33 4.33
4 0.75 2.88 3.63
5 0.6 2.6 3.2
6 0.5 2.5 3
7 0.43 2.57 3
8 0.375 2.88 3.25
9 0.33 3.44 3.8
10 0.3 4.3 4.6
Formula:
Total Fixed Cost
Average Fixed Cost = Total Output
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AFC is the amount of fixed cost allocated to the production of one unit of a
product.
As the outputs increase, the average fixed cost decrease.
Formula:
Total Variable Cost
Average Variable Cost (AVC) = Total Output
As the outputs increase, the average variable cost will decrease to a point after which
it will start to increase.
Formula:
Total Cost
Average Cost (AC) = Total Output
It is the sum total when Total Average Fixed Cost and Total Average Variable Cost is
added.
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Average
Pric Total Revenue
Quantity e Revenue
Demand curve is the quantity demand at each price – therefore the higher the price
the less quantity of a product is demanded. The demand curve is downward sloping.
A revenue curve reflects the amount of money a business earns from the sale of
goods and services. It is the price per unit.
If the business wants to sell extra units then they must cut the price – The Average
Revenue curve is also downward sloping.
NB: The Average Revenue curve is the same as the Demand curve.
Average cost
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Tot
Quanti al Avera
ty Pric TF TV cos AV ge
Output e C C t C cost
0 100 10 0 10
1 90 10 10 20 10 20
2 80 10 18 28 9 14
8.3
3 70 10 25 35 3 11.67
8.2
4 60 10 33 43 5 10.75
5 50 10 43 53 8.6 10.6
9.1
6 40 10 55 65 7 10.83
7 30 10 70 80 10 11.43
11.
8 20 10 90 100 3 12.5
11 12.
9 10 10 5 125 8 13.89
14 14.
10 0 10 5 155 5 15.5
As the firm produces more of a product the average cost reduces to a certain point
then it increases again.
The reason is average cost has a fixed part and a variable part. Adding them
together the AC will decrease to a point and then start to increase.
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Marginal cost
Pric
Quantity / Output e Total cost MC
0 100 10
1 90 20 10
2 80 28 8
3 70 35 7
4 60 43 8
5 50 53 10
6 40 65 12
7 30 80 15
8 20 100 20
9 10 125 25
10 0 155 30
Marginal cost is the cost of the resources to produce an additional product. (What
does it cost to produce one additional unit?)
The cost to produce an additional unit will decrease to a point (5 units) then it will
increase again.
Long run refers to the time period where both fixed factors and Variable factors
change.
E.g. business enterprises need time to:
expand their business property.
install new machinery.
to develop new production techniques.
The law of diminishing returns does not influence the business because businesses
can make any changes.
The long term curve differs from the short term curve.
The most important decisions that enterprises have to take into consideration are the scale
of their operations.
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REVENUE CALCULATIONS AND CURVES
PERFECT COMPETITION
TOTAL REVENUE
Total revenue is the amount of money that a business earns in a particular period of
time.
A business earns money by selling its output.
TR = Q x P
7 4 28
8 4 32
9 4 36
10 4 40
AVERAGE REVENUE
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Average revenue refers to the amount the enterprise earns for every unit sold. Also referred
to as unit cost.
AR = TR
Q
When every product is sold for the same price the average revenue will simply equal the
price of the product.
AR = P
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MARGINAL REVENUE
Marginal revenue refers to the extra amount of income earned when an additional
(extra) unit of a product is sold.
MR = ∆TR
∆Q
Margina
Total l
Quantit Pric Revenu Revenu
y e e e
0 4 0 4
1 4 4 4
2 4 8 4
3 4 12 4
4 4 16 4
5 4 20 4
6 4 24 4
7 4 28 4
8 4 32 4
9 4 36 4
10 4 40 4
TOTAL REVENUE
Total revenue is the amount of money that a business earns in a particular period of
time.
A business earns money by selling its output.
TR = Q x P
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QUANTITY / Output Price Total Revenue
0 0
10 8 80
20 7 140
30 6 180
40 5 200
50 4 200
60 3 180
70 2 140
Total revenue increase as the level of output increase to a certain amount but then it
decreases again.
AVERAGE REVENUE
Average revenue refers to the amount the enterprise earns for every unit sold.
AR = TR
Q
When every product is sold for the same price the average revenue will simply equal
the price of the product.
AR = P
0 0
10 8 80 8
20 7 140 7
30 6 180 6
40 5 200 5
50 4 200 4
60 3 180 3
70 2 140 2
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MARGINAL REVENUE
Marginal revenue refers to the extra amount of income earned when an additional
(extra) unit of a product is sold.
MR = ∆TR
∆Q
The MR decrease with each additional unit of output as the level of output increase.
Point e
At point e the business produces at maximum profit where marginal income equals
marginal cost (MR = MC).
This is known as the equilibrium point or profit maximization point.
Point a:
At point a the marginal revenue is greater than marginal cost: (MR˃MC). (Marginal
revenue lies above the marginal cost)
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If the business produces at the level of point a, then the business can increase the
level of poduction until the profit maximization point is reached (point e).
This is because every additional unit of production will add to the total profit of the
business.
Point c:
At point c the marginal revenue is smaller than marginal cost (MR ˂MC). (Marginal
revenue lies below the marginal cost).
If the business produces at the level of point c, then the business must decrease the
level of production until the profit maximization point is reached (point e).
This is because every additional unit of production will contribute to the decrease in
profits. (Add to the losses of the business).
Conclusion:
1. MR = MC: Maximum profit
2. MR ˃ MC: Every additional unit produced adds to the profit of the business.
3. MR ˂ MC: Every additional unit produce will contribute to the decrease in profits.
(add to the loss of profits).
Imperfect Competition
Profit maximization
The monopolist maximize its profits were at the level of output where Marginal Cost
is equal to Marginal Revenue: (MC = MR)
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PROFIT AND LOSS
PRICE TAKERS: They do not influence the prices for which products sell. They accept the
market price.
PRICE MAKERS (SETTERS): (Monopolies): They influence the price of products. They can
decide within limits at what price to sell their products.
E.g. diamond mines.
PRICE LEADERS: (E.g. oligopoly): They are large firms. They initiate price changes and
smaller businesses follow by increasing the prices of their products accordingly.
They lead with prices and other companies follows.
E.g. large supermarkets, travel agencies, etc.
Accounting profit
Also known as total profit.
It is the difference between total revenue from sales and total costs.
Accounting profit = Revenue minus explicit costs.
Normal profit
It is the minimum return required by the owners to continue with the
business.
It is the remuneration for entrepreneurship.
It is included in the total cost of production.
When revenue is equal to explicit cost plus implicit costs.
Economic profit
It is the extra profit that the firm makes.
It is the profit that the business makes in addition to the normal profit.
It is also known as surplus or excess or extra profit.
Economic profit = Revenue minus explicit plus implicit costs.
PROFIT AND LOSS IN THE PERFECT PROFIT AND LOSS IN THE IMPERFECT
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MARKET MARKET
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TOPIC 6: SELF ASSESSMENT ACTIVITIES
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1. Study the graphs below and answer the questions that follow.
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Activity 2
2.1 Study the cartoon below and answer the questions that follow.
2.1. Name the market structure depicted on the above cartoon. (1)
2.2.1 Identify the barrier to entry from the cartoon above. (1)
2.3 Describe the term monopoly. (2)
2.4 Briefly explain how natural monopolies are created. (2)
2.5 Why would a monopolist continue to make economic product in the long-run? (4)
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