Theory of Cost & Revenue

Chapter 7  Theory of Costs Cos ts and Revenue Revenue Costs

Introduction

• Main objective of a rm : Prot Maximisation • Prot  Revenue ! Cost of Production • Cost of production is the expenditure incurred by a rm "hen producin# a #iven $eve$ of output • Revenue is the tota$ income earned by a rm "hen it se$$s a #iven $eve$ of output

 Types of Costs  Types Cos ts Costs • %conomic Costs • Private vs &ocia$ •  T  Time ime %$ement ' Costs

%conomic Costs %xp$icit Costs

Imp$icit Costs

• Incurred "hen a rm hires or purchases a factor of production

• Imputed costs of a rm "hen it uses its o"n factors of production

•  Termed as Money Costs

• Ca$cu$ated based on opportunity cost

*orma$ Prots • Minimum prots re(uired to )eep the entrepreneur in production in the $on# run

%conomic Costs %xp$icit cost • +ast +ans ,td borro"s money from the ban) ./ p0a0 to buy a machine

5 &

Imp$icit cost • +ast +ans ,td uses its o"n money 1reserves and surp$us2 to buy a machine • 3pportunity cost of usin# the rm4s o"n money is the Imp$icit Cost

Private vs &ocia$ Costs • Private Costs : incurred by a rm "hen it produces a commodity ! %#: cost of ra" materia$

• &ocia$ Costs : borne by society as a "ho$e "hen a rm produces a commodity ! %#: $oss of marine $ife from po$$utants from production process

 Time %$ement and Costs 5ery &hort Run  5ery • 6$$ factors are xed • Costs remain constant • +ixed costs

 Time %$ement and Costs  Time 5ery &hort Run  5ery • 6$$ factors are xed • Costs remain constant • +ixed costs

&hort Run • 3ne factor is variab$e others xed • Cost chan#es to the extent of variab$e factor • 5ariab$e cost ' +ixed cost

 Time %$ement and Costs  Time 5ery &hort Run  5ery • 6$$ factors are xed • Costs remain constant • +ixed costs

&hort Run • 3ne factor is variab$e others xed • Cost chan#es to the extent of variab$e factor • 5ariab$e cost ' +ixed cost

,on# Run • 6$$ factors are variab$e • Costs chan#eab$e • 5ariab$e costs

Costs in the &hort Run •  T  Tota$ ota$ +ixed +ixed Cost C ost Co st 1T+C2 ! Costs that do not chan#e "ith the chan#e in output

•  T  Tota$ ota$ 5ariab$e 5ariab$e Cost 1T5C2 ! Costs that chan#e "ith the chan#e in output

•  T  Tota$ ota$ Cost  TC  T+C 8 T5C  TC

 Tota$ +ixed Costs    2   s    R    1    t   s   o    C    d   e   x    i    +    $   a    t   o    T

 T+C

Output TFC  (Q) (Rs) 0 1 2 3 4 5 6

100 100 100 100 100 100 100

3utput TFC 1@2 1Rs2

   t   s   o    C   e    $    b   a    i   r   a    5    $    2   a    t  s   o    R    T    1

 9 ; < > = ? 7

9 9 9 9 9 9 9 9

TVC

1Rs2

 Tota$ 5ariab$e Cost

 ; = ? 7

9 9 9 9 9 9 9 9

 ;