Revenue, Production, and Cost Analysis

Economic Development (Module 2)

3. Marginal Revenue (MR)

THE ROLE OF THE FIRM ●​ additional amount of money received from the
The firm is an economic institution that transforms sales of one additional unit of a product or
factors of production into consumer goods, it: output.
●​ Organizes factors of production. ●​ MR = Change in TR / Change in Q
●​ Produces goods and services.
●​ Sells produced goods and services. A FIRM’S PROFIT
Profit is the firm's total revenue minus its total cost.
The Firm's Objective
Profit = Total revenue - Total cost
●​ The economic goal of the firm is to maximize
profits
Total Cost includes all of the opportunity costs of
REVENUE production
●​ the income that a firm receives from the sale EXPLICIT COST
of a good or service to its customers
●​ the opportunity costs of a firm’s resources that
●​ Total amount of money value received by a
take the form of cash payments
firm or an industry by selling the goods and
●​ These resources are owned outside the firm
services
and must be purchased with actual payments
●​ calculated by multiplying the price (p) of the
to “outsiders.”
good by the quantity produced and sold (q)
○​ in algebraic form: R = p × q
EXAMPLES:​
EXAMPLE: if a firm produce 100 units of commodity Wages and salaries, Rental charges, Cost of
per day and sells it at P20 per unit, then its total electricity, Cost of materials, Cost of medical
revenue is P2,000 per day insurance, Taxes

CATEGORIES OF REVENUE IMPLICIT COST

●​ Each curve have different characteristics for ●​ the opportunity costs of using resources
different market structure owned by the firm
●​ EXAMPLES: Opportunity cost to earn a salary
1. Total Revenue (TR) as an electrical engineer, Opportunity cost of
●​ Total sum of money value received from the earning rental payments
sales of various quantities of output of product
produced during a given period of time at ECONOMIC AND ACCOUNTING PROFIT
certain price level Profit = total revenue – total cost
○​ known as total revenue of a firm or an Accounting profit = total revenue – total explicit cost
industry for that time period Economic Profit = total revenue – total opportunity
●​ can be obtained by multiplying total output costs
sold (Q) by the corresponding price (P)​ Economic Profit = total revenue – (explicit costs +
TR = P × Q implicit costs)

2. Average Revenue (AR)

●​ Per unit revenue of a product
●​ We obtain AR by dividing (TR) by the
corresponding quantity sold (Q)​
AR = TR/Q

AUTHOR/S: (REYES, A.M): BSA-1A

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Revenue, Production, and Cost Analysis
Economic Development (Module 2)

ILLUSTRATION: NORMAL PROFIT

Suppose Mang Donalds is an electrical engineer by ●​ the minimum profit necessary to keep a firm in
profession but he decided to establish a company. operation
Let’s named it Mang Donalds’ Computer World! With ●​ A firm that earns normal profits earns total
the establishment of his company, he needs the revenue equals to its total opportunity costs
following: employees, materials, payments for
interest, and others. Zero economic profit
●​ signifies there is just enough total revenue to
Other things to consider: IMPLICIT COSTS pay the owners for all explicit and implicit
●​ The opportunity cost of earning a huge salary costs
by being an electrical engineer abroad.
●​ The opportunity cost of earning rental
payments (because of the establishment of
the company, he needs to use his building as
a warehouse).
●​ Opportunity cost of earning interest with your
money in the bank (because he used his
5,000 pesos in the company)

TECHNOLOGY
●​ production process that define how a firm can
combine or convert inputs into outputs
PRODUCTION FUNCTION
●​ is a function that describes the efficient
combination of inputs to produce a certain
level of output
●​ (the maximum amount of any output a
ECONOMIC LOSS producer can get most efficiently, given a
●​ Occurs when a firm has an economic profit certain level of inputs; or the minimum amount
value of less than zero. of inputs required to produce a level of output)
●​ the firm is not earning enough to cover its
opportunity costs; its resources would receive MARGINAL PRODUCT
a higher return somewhere else. ●​ is the additional output that will be forthcoming
●​ Pulls resources out of an industry from an additional unit of input, other inputs
remaining constant
PURE ECONOMIC PROFIT
●​ A positive economic profit. AVERAGE PRODUCT
●​ This means the firm is earning more than its ●​ calculated by dividing total output by the
opportunity costs. quantity of the input
●​ Pulls resources into an industry.
PRODUCTION TABLE

AUTHOR/S: (REYES, A.M): BSA-1A

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Revenue, Production, and Cost Analysis
Economic Development (Module 2)

GRAPHICAL REPRESENTATION OF TP, AVERAGE VARIABLE COST

PRODUCT, AND MARGINAL PRODUCT CURVES ●​ those that change as output changes.
●​ Workers represent variable costs

FAMILY OF TOTAL COST

●​ Total Fixed Costs (TFC)
●​ Total Variable Costs (TVC)
●​ Total Costs (TC)
●​ TC= TFC + TVC

The Law of Diminishing Marginal Productivity

●​ Both marginal and average productivity
initially increase, but eventually they both
decrease.
●​ This means that initially the production
function exhibits increasing marginal
productivity.
●​ Then it exhibits diminishing marginal
AVERAGE FIXED COST
productivity.
●​ equals fixed cost divided by quantity
●​ Finally, it exhibits negative marginal
produced. AFC = FC/Q
productivity.
AVERAGE VARIABLE COST
●​ equals variable cost divided by quantity
produced. AVC = VC/Q

AVERAGE TOTAL COST

●​ can also be thought of as the sum of average
fixed cost and average variable cost.
●​ ATC = AFC + AVC

MARGINAL COST
●​ is the increase (decrease) in total cost of
increasing (or decreasing) the level of output
by one unit.
MC = (Change in total cost) / (Change in quantity)

Average and Marginal Cost Curves

FIXED COST
●​ are those that are spent and cannot be
changed in the period of time under
consideration.
●​ In the long run, there are no fixed costs
since all costs are variable.
●​ In the short run, a number of costs will be
fixed. ●​ The marginal cost curve goes through the
minimum point of the average total cost curve
and average variable cost curve.

AUTHOR/S: (REYES, A.M): BSA-1A

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Revenue, Production, and Cost Analysis
Economic Development (Module 2)

●​ Each of these curves is U-shaped.

●​ The average fixed cost curve slopes down
continuously.
●​ As output increases, the same fixed cost can
be spread out over a wider range of output.

The U Shape of the Average

and Marginal Cost Curves
The law of diminishing marginal productivity sets
in as more and more of a variable input is added to a
fixed input.
●​ Marginal and average productivities fall and
marginal costs rise.
●​ When average productivity of the variable ●​ If MC > ATC, then ATC is rising.
input falls, average variable cost rises. ●​ If MC = ATC, then ATC is at its low point
●​ The average total cost curve is the vertical ●​ If MC < ATC, then ATC is falling.
summation of the average fixed cost curve
and the average variable cost curve. SHORT RUN
●​ at least one resource is fixed
●​ For some producers, the short run lasts a few
days. For others, the short run can last for 3
years
LONG RUN
●​ no resource is fixed
●​ The difference between short run and long run
depends on the particular production activity

Costs in the Long Run

For many firms, the division of total costs between
Relationship Between Marginal​ fixed and variable costs depends on the time horizon
and Average Costs being considered.
●​ Marginal and average total cost reflect a In the short run, some costs are fixed.
general relationship that also holds for In the long run, fixed costs become variable costs.
marginal cost and average variable cost.
​

ECONOMIES OF SCALE
●​ A situation in which long-run average cost
declines as the firm increases its level of
production.​

AUTHOR/S: (REYES, A.M): BSA-1A

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Revenue, Production, and Cost Analysis
Economic Development (Module 2)

The reasons for this are: marginal productivity of labour to the marginal
1.​ A greater scale of operation allows for greater productivity of machines.
specialization of labor.
2.​ A greater scale allows the firm to take Slope = MP labour / MP machine
advantage of technologically advanced = Marginal Rate of Technical Substitution
specialized equipment which would not be
cost effective at lower output

CONSTANT RETURNS TO SCALE

●​ A situation in which long-run average cost
does not change with the level of output
●​ If output doubles, total cost also doubles
●​ cost per unit of output remains unchanged
●​ The Long Run average cost curve will become
flat as a result of constant returns to scale
DISECONOMIES OF SCALE
●​ A situation in which the long-run average cost
curve rises as the firm increases output
ISOCOST LINE
●​ A very large-scale firm becomes harder to
manage ●​ “equal cost”
●​ As the firm grows, the chain of command ●​ represents alternative combinations of factors
lengthens, and communication becomes of production that have the same cost.
complex ●​ The slope of the isocost line equals the ratio
of prices of the factors of production.
It is no surprise that a firm can become too big, and
management problems can cause the average cost of
production to rise.

ISOQUANT CURVE
●​ “equal quantity”
●​ represents combinations of factors of
production that result in equal amounts of
output.
●​ A point on the isoquant curve is technically
efficient.

Marginal rate of technical substitution CONTRIBUTION MARGIN

●​ the rate at which one factor must be added to ●​ is used first to cover fixed expenses
compensate for the loss of another factor, to ●​ Any remaining CM contributes to net
keep output constant. operating income.
●​ It is the slope of the isoquant curve.
●​ The absolute value of the slope at a point
on the isoquant curve equals the ratio of the

AUTHOR/S: (REYES, A.M): BSA-1A

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Revenue, Production, and Cost Analysis
Economic Development (Module 2)

CONTRIBUTION APPROACH EQUATION FORM

●​ Sales, variable expenses, and contribution ●​ When a company has only one product we
margin can also be expressed on a per unit can further refine this equation as shown
basis. below
EXAMPLE:​
If Racing sells an additional bicycle, $200 additional
CM will be generated to cover fixed expenses and
profit.

It is often useful to express the simple profit

equation in terms of the unit contribution margin (Unit
CM) as follows:

Each month, RBC must generate at least $80,000 in Profit = (P × Q – V × Q) – Fixed expenses
total contribution margin to break-even (which is Profit = (P – V) × Q – Fixed expenses
the level of sales at which profit is zero). Profit = Unit CM × Q – Fixed expenses

PREPARING BREAK-EVEN GRAPH

If RBC sells 400 units in a month, it will be operating

at the break-even point.

Contribution Margin Ratio (CM Ratio)

If RBC sells one more bike (401 bikes), net operating

income will increase by $200

AUTHOR/S: (REYES, A.M): BSA-1A

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