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Costs and Profit
1. Profit determination
Revenue
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Costs and Profit
1. Profit determination
Revenue-
Income earned from sales.
Total Revenue Gross income from all sales
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Costs and Profit
1. Profit determination
Profit
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Costs and Profit
1. Profit determination
Profit-
The amount remaining when costs are
subtracted from revenue.
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Costs and Profit
1. Profit determination
Costs
a) Explicit Costs
b) Implicit Costs
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Costs and Profit
1. Profit determination
Costs
a) Explicit Costs
Explicit costs involve an actual payment of money
b) Implicit Costs
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Costs and Profit
1. Profit determination
Costs
a) Explicit Costs
Explicit costs involve an actual payment of money
b) Implicit CostsImplicit costs are those that you know you bear,
but you do not actually pay.
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Costs and Profit
Revenue
- Explicit Costs
Financial Profit (or Accounting Profit, or Simple Profit)
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Costs and Profit
Revenue
- Explicit Costs
Financial Profit (or Accounting Profit, or Simple Profit)- Implicit Costs
Economic Profit
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Costs and Profit
Four major costs
All of the major costs are
Explicit Costs
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Costs and Profit
Four major costs
Fixed Cost (FC)
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Costs and Profit
Four major costs
Fixed Cost (FC)
Costs that remain the same as the
number of units produced changes.
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Costs and Profit
Four major costs
Fixed Cost (FC)
Variable Cost (VC)
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Costs and Profit
Four major costs
Fixed cost (FC)
Variable cost (VC)
Costs that change as the numberof units produced changes
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Costs and Profit
Four major costs
Fixed Cost (FC)
Variable Cost (VC)
Total Cost (TC)
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Costs and Profit
Four major costs
Fixed Cost (FC)
Variable Cost (VC)
Total Cost (TC)The total cost of production, equal
to Fixed Cost plus Variable Cost
(FC + VC = TC)
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Costs and Profit
Four major costs
Fixed Cost (FC)
Variable Cost (VC)
Total Cost (TC)Marginal Cost (MC)
d f
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Costs and Profit
Four major costs
Fixed Cost (FC)
Variable Cost (VC)
Total Cost (TC)Marginal Cost (MC)
The cost of producing one additional
unit. The formula for marginal cost isMC = TC/ Units
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Total Cost Curves
Cost
Units Produced
0
d fi
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Costs and Profit
Three minor costs
Average Fixed Cost (AFC)
C d P fi
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Costs and Profit
Three minor costs
Average Fixed Cost (AFC)
Fixed cost divided by units produced
C d P fi
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Costs and Profit
Three minor costs
Average Fixed Cost (AFC)
Average Variable Cost (AVC)
C d P fi
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Costs and Profit
Three minor costs
Average Fixed Cost (AFC)
Average Variable Cost (AVC)
Variable Cost divided by units produced
C t d P fit
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Costs and Profit
Three minor costs
Average Fixed Cost (AFC)
Average Variable Cost (AVC)
Average Total Cost (ATC)
C t d P fit
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Costs and Profit
Three minor costs
Average Fixed Cost (AFC)
Average Variable Cost (AVC)
Average Total Cost (ATC)-
Total Cost divided by units
produced (or AFC + AVC = ATC)
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Average Cost Curves
Cost
Units Produced
0
C t d P fit
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Costs and Profit
The Point of Diminishing Returns
That point in a continuing production
setting where the continued application of
variable cost resources results in
production beginning to increase at a
decreasing rate.
C t d P fit
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Costs and Profit
Long Run and Short Run are not specific time
periods.
The Short Run is a production period that is too
short to allow for fixed-cost assets to be changed.
The Long Run is an average of two or more short
run scenarios.
Production always takes place during a short run.
C t d P fit
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Costs and Profit
Returns to Scale
In a production setting, costs are accounted for inconstant amounts. Rather than figuring out how
much each unit costs, businesses keep track of howmany units are produced per dollar (or thousand
dollars, or million dollars).
This increment of costs is referred to as the scaleby which we measure production. The units
produced are referred to as returns to scale.
Costs and Profit
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Costs and Profit
Returns to Scale
There are three possible returns.1. Increasing (positive) returns to scale When
each additional dollar spent results in more
additional units being produced.
Costs and Profit
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Costs and Profit
Returns to Scale
There are three possible returns.1. Increasing (positive) returns to scale When
each additional dollar spent results in more
additional units being produced.2. Constant (neutral) Returns to Scale - When each
additional dollar spent results in the same
number of additional units being produced.
Costs and Profit
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Costs and Profit
Returns to Scale
There are three possible returns.1. Increasing (positive) returns to scale When
each additional dollar spent results in moreadditional units being produced.
2. Constant (neutral) Returns to Scale - When eachadditional dollar spent results in the same
number of additional units being produced.
3. Decreasing (negative) Returns to Scale - Wheneach additional dollar spent results in fewer
additional units being produced.
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Costs and Profit
Returns to Scale
When viewed on the Average Total Cost (ATC) curve,the three sections are fairly obvious.
1. As long as the curve is descending, we are in the
Increasing Returns range.
Costs and Profit
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Costs and Profit
Returns to Scale
When viewed on the Average Total Cost (ATC) curve,the three sections are fairly obvious.
1. As long as the curve is descending, we are in the
Increasing Returns range.2. When the curve levels and is parallel toX, we
are in the Constant Returns range.
Costs and Profit
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Costs and Profit
Returns to Scale
When viewed on the Average Total Cost (ATC) curve,the three sections are fairly obvious.
1. As long as the curve is descending, we are in the
Increasing Returns range.2. When the curve levels and is parallel toX, we
are in the Constant Returns range.
3. When the curve begins to rise, we are in theDecreasing Returns range.
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Economy of Scale
Cost
Units Produced
0
Costs and Profit
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Costs and Profit
Returns to Scale
Using the Average Total Cost (ATC) curve, it is alsoeasy to identify the area of greatest efficiency of
production.
This is known as Economy of Scale.
Costs and Profit
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Costs and Profit
Economy of Scale
Cost savings that are due to a firms large size or highlevels of production output.
There are four things that result in cost savings thatlarge firms can do, and smaller firms cannot.
These are the four reasons for Economy of Scale.
Costs and Profit
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Costs and Profit
Economy of Scale
Four reasons for Economy of Scale1. Bulk Rate Discounts
Costs and Profit
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Costs and Profit
Economy of Scale
Four reasons for Economy of Scale1. Bulk Rate Discounts
2. Efficient Use of Human Resources
Costs and Profit
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Costs and Profit
Economy of Scale
Four reasons for Economy of Scale1. Bulk Rate Discounts
2. Efficient Use of Human Resources
3. Efficient Use of Capital Equipment
Costs and Profit
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Costs and Profit
Economy of Scale
Four reasons for Economy of Scale1. Bulk Rate Discounts
2. Efficient Use of Human Resources
3. Efficient Use of Capital Equipment4. Efficient Use of By-Products
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Costs and Profit
Profit Determination
There are two basic methods of calculating profit,and determining the most profitable point of
production (PMLPprofit maximizing level of
production).1. Total Cost basis
2. Marginal Cost basis
Profit Determination
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Profit Determination
Total Cost Basis
C
ost
Units Produced
0
Profit Determination
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Profit Determination
Marginal Cost Basis
C
ost
Units Produced
0
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