THEORY OF

COST AND PROFIT

HUNGRY HELENS
COOKIE FACTORY
Helen, the owner of the cookie factory,
buys flour, sugar, flavourings, and other
cookie ingredients.
She also buys the mixers and the ovens
and hires workers to run the equipment.
She then sells the resulting cookies to the
consumers.

TOTAL REVENUE, TOTAL

COST, AND PROFIT
The amount that Helen receives for the sale of its
output (cookies) is its total revenue.
The amount that the firm pays to buy inputs (flour,
sugar, workers, ovens, etc.)
is called total cost.
We define profit as a firms total revenue minus its
total cost.
PROFIT = TOTAL REVENUE TOTAL COST

TOTAL REVENUE, TOTAL

COST, AND PROFIT
Helens objective is to make her firms
profit as large as possible.
To see how a firm goes about maximizing
profit, we must consider fully how to
measure its total revenue and its total
cost.

TOTAL REVENUE, TOTAL

COST, AND PROFIT
Total revenue is the easy part, it is just
Total Revenue = Price x Quantity.
The measurement of a firms total cost is
more complicated.
When measuring cost of any firm, its more
important to keep in mind that the cost of
something is what you give up to get it.

Accounting
Cost
&
Economic
Cost

Fixed Cost
&
Variable
Cost

Cost
Concept
s
Direct Cost
&
Indirect Cost

Outlay Cost
&
Opportunity
Cost

OUTLAY COST & OPPORTUNITY COST

Outlay Costs involves actual expenditure
of funds and recorded in the Book of
Accounts. (Wages, Rent, Interest, etc.)
Opportunity Costs are the Return
Expected from the second best use of the
resources, which is forgone for availing the
Gains from the best use of the resources.
It is not recorded in the Book of Accounts.

DIRECT COST & INDIRECT COST

Direct Costs are costs that are readily
identified and are traceable to a particular
product, operation or plant.
Indirect Costs are costs that are not
readily identified and are not traceable to
a particular product, operation or plant.

FIXED COST & VARIABLE COST

Fixed Costs are expenses that does not
change in proportion to the activity of a
business.
Variable Costs are expenses that change
in direct proportion to the activity of a
business such as sales or production
volume.

SHORT RUN

Decision making in the

different time periods
Short run for the firms and very short run
for the industry.
Long run for the firms and short run for the
industry.
Very long run for the firms and long run for
the industry.

THEORY OF COSTS
Costs of a firm is incurred to establish the
production unit and to purchase different factors
of production.
Cost of a firm (TC) is classified into two broad
categories Fixed cost (TFC) and Variable
cost
(TVC).
i.e. TC = TFC + TVC
However, nothing is fixed in the long run.

Short Run Average

Costs

Average
Fixed Cost

Average
Variable
Cost

Average
Total Cost

LONG RUN

 In the long run, firms change production

levels in response to (expected) economic
profits or losses, and the land, labor,
capital goods and entrepreneurship vary to
reach associated long-run average cost.

LONG-RUN COST CURVES

It is a period of time during which the
quantities of all factors, variable as well as
fixed can be adjusted.

ECONOMIC PROFIT
VERSUS ACCOUNTING
Again, the firms objective is to make profit
PROFIT

As economists measures a firms economic

profit as a total revenue minus all the opportunity
costs (explicit and implicit) of producing the goods
and services sold.
An accountant measures the firms accounting
profits as the firms total revenue minus the
firms explicit costs.

THE END
Minnasan, Arigato Gozaimasu :D