Module III Concepts of Revenue and cost

• Costs, various concepts of cost and revenue in short and long run.
• Cost and revenue curves
• Meaning of market, types-Perfect, Monopoly, Oligopoly, Monopolistic (Main features)

The concept of revenue

Revenue, in economics, the income that a firm receives from the sale of a good or service to its customers.
Technically, revenue is calculated by multiplying the price (p) of the good by the quantity produced and sold
(q). In algebraic form, revenue (R) is defined as R = p × q.

Revenue is what keeps your business alive. Beyond being a lifeline, revenue can give you key insights into
your business. If you want to increase your business profits, you need to increase your revenue. By keeping
an eye on your revenue and focusing on increasing it, you can also increase your profits.
.
A simple way to solve for revenue is by multiplying the number of sales and the sales price or average
service price (Revenue = Sales x Average Price of Service or Sales Price).

Type of Revenue
TR = Price * Quantity
AR = TR / Quantity
MR = TR(n) – TR (n-1)

Revenue in imperfect competition (Product is heterogeneous)

Q P TR AR MR
1 5 5 5/1 =5 5
2 4 8 8/2 =4 8-5 =3
3 3 9 9/3 = 3 9-8 =1
4 2 8 8/4 = 2 8-9 =-1
5 1 5 5/5 = 1 5-8 =-3

Revenue in perfect competition (product is homogeneous )

Q P TR AR MR
1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10
COST ANALYSIS

TYPE OF COST:

1-Explicit Cost - It refer to money expanses incurred on both hired fixed actor input as well as purchased
non- factor input. These include wages, rent, interest and payment made for raw material, payment for
the use of power.

2-Implicit Cost – cots of self-owned resources employed in the production of a commodity are known as
implicit cost. These include payment for self-owned premises; self invested capital and self labour.

3-Opportunity Cost – opportunity costs of a commodity is the next best alternative sacrificed in order to
produce that commodity it is also defined as the cost of foregone alternatives.

4-Private Cost- private costs refer to the cost incurred by a firm in producing a commodity. It is actually
the money cost which a firm incurs on hiring and purchasing the resources of factor of production for
producing a commodity.

5-Social Cost – social costs refer to the cost of producing commodity to the society as a whole like
pollution of air.

6-Fixed Cost (FC) - fixed costs are the cost which does not change with the change in size of out put
during short period. These are incurred primarily on fixed factors like machines, buildings whose supply
remains fixed in short period.

Total fixed schedule-

No. Of units produced TFC

0 10 20 -
1 10 15 - TFC
2 10 10 -
3 10 5 -
4 10 0 I I I I ı
5 10 1 2 3 4 5 6
OUTPUT

7- Average Fixed Cost (AFC)- it is the unit fixed cost of producing a commodity. Afc is derived by dividing
the total fixed cost by the number of unit of commodity produced

AFC = TFC
Q

No. Of units produced TFC AFC

0 10 ∞ 12−
1 10 10 10−
2 10 5 8 −
3 10 3.3 6 −
4 10 2.5 4 − AFC
5 10 2 2 −
0 I I I I I I
1 2 3 4 5 6
This curve will never touch the x-axes because average fixes cost cannot be zero, how ever large the level of
output may be. Similarly, AFC curve never touches the y- axes. It is so, become TFC is a positive value at
zero output and positive value divided by zero. Will provide infinite value AFC is a rectangular hyperbola.

8-Total Variable Cost (TVC) –These are COST which very directly with change in the size of the of output
like labour, raw material, power Fuel, were and tear of machines etc. When the production stops variable
COST becomes zero. TVC intrally increase at diminishing rate after that increase at increasing rate.

Total output TVC — TVC

0 0 —
1 10 —
2 18 —
3 26 —
4 35 —

5 50 I I I I I I

9-Aaverage Variable Cost (AVC) – Average variable cost in the per unit variable cost of producing
a commodity. This is calculated by dividing the total variable cost by number of unit produced.
TVC
AVC =
Q

Unit TVC AVC 10— AVC

1 10 10 8—
2 18 9 6—
3 26 8.6 4—
4 35 9.7 2—
5 50 10 0 I I I I I ı
1 2 3 4 5 6
Unit

In the beginning AVC decrease but after reaching , it start increasing AVC became usually U-shaped. Because
of low of variable proportions.

10-Total Cost (TC)- total COST is the total expenditure incurred by the firm in procuring factor input and
non factor in put required for production of a commodity .it is the sum…..of total fixed cost TFC and total
variable cost TVC .

Unit TFC TVC TC TC

0 10 0 10 40−
1 10 10 20 30−
2 10 18 28 20−
3 10 26 36 10−
4 10 35 45 0 I I I I I
5 10 50 65 1 2 3 4 5

TC curve and TVC curve have similar shapes expect that TVC start firm zero level of output wheaies TC
curve start on y-axis firm a point having distance equal to TC. The two curves remain parallel to each other.
11-Average Cost (AC)- average- total cost is per unit cost production. It is Calculated by dividing the total
cost by number of unit produced.
TC
AC =
Q

AC is the sum of AFC and AVC. if TFC remain constant when unit of production or output are increased then
AC will decline.

Unit TC AC 25− AC
1 20 20 20−
2 36 18 15−
3 48 14 10−
4 56 14 5 −
5 70 16 0 I I I I I I
1 2 3 4 5 6
AC curve is generally unit-shape curve

12-Marginal COST (MC) - marginal COST is addition to the total COST when an additional unit of a
commodity is produced or when output is increased by one unit .MC is related to variable COST and not to
fixed cost MC curve falls initially when production increase but after a point, it rises rapidly which is due to
operation of law of variable production.

Unit TC AC − MC
1 20 20 −
2 36 16 −
3 48 12 −
4 56 8 −
5 70 14 I I I I I I
6 56 16 Unit

Relation Between AC MC And AVC-

1.
When average cost falls with an increase in output marginal cost is less then average cost.
2.
marginal cost begins to rise earlier ……the average cost .MC cost The AC at its minimum point.
3. With increase in average cost , MC rises at a faster rate

4.
MC intersed AVC at their minimum point.
5.
When AVC declines AC also declines. AVC curve is below AC curve.

COST

Output

6.
AVC reaches its minimum point ‘A’ before AC reaches its lowest point.
7.
When AVC rises AC also rises. Hence both the two curve have Unit-shape.
8. Initially there is a big gap between AC and AVC and the gap narrows down with the increase in output
because of fall in AFC.
9. MC cut AC and AVC at their lowest point.
 Short run period – Short period is the time which is so short that a firm can not change some of its factor
of Production like plant, machinery, building etc. In short period, fixed capital ( in the form of machinery and
building ) and organization are considered as fixed factors consequently production can be inversed only to
the extent which is possible by using fixed factor to their full capacity and by increasing the variable factors
like raw material ,power.

Law of diminishing returns- This law can be stated as if more and more unit of a variable unit of a variable
input are applied to given amount of a fixed input , the marginal cost initially decrease, but eventually
increase.

Why AC Unit-Shaped- Short run average cost curve is ‘U’ shaped. It means that at first this curve falls and
after reaching the minimum point it begins to rise the following are the main cause of the ‘U’ shaped of average
cost curve.

Basis Of Average Fixed COST And Average Variable COST- Average cost is the summation of average
fixed cost and average variable cost . with every increase input output AFC continues to fall . The average
variable cost continuous to fall in the beginning, till it reaches its minimum. Point then it begin to rise , Thus
AC tends to decrease inically, stabilize subsequently and rise finally…….. Findlay rise become at later stage
of output.

Basis Of Law of Variable Proportion- Initially, when variable factors are combined with a fixed factor than
fixed factor is more efficiently used, consequently , AC begin to diminish after the fixed factor have been
Optimally used producing increase at a rate. This signifies the operation of law of variable proportion return
to a factor or low of increasing cost .this is why AC curve begin to rise.

Basis Of Internal Economies And Diseconomies- When a firm in short period increases its production then
it enjoy several type of internal economies like technological economies marketing economies etc.
As a result of it average costs begin to firm experience diseconomies of scale. Consequently AC begin to rise
and AC curve begin to more upward

Long Run COST –Output Relations- Long run is a period in which all the input become variable and the
variability of input is based on the assumption that in the long run become elastic. the firm are therefore in
position to expand the scale of their production by hiring a large number of all the input and the long run cost
output The relationship between the changing scale of the firm and the total output, whereas in the short run
this relation is essentially one between the output and variable cost .
Long run is combination of a short run production decisions.

Long Run Total Cost Curve (LTC)- In short run that a firm having only one plant has its short run total cost
curve as given by STC, let us suppose that the firm decides to add two more plants of same size over time ,one
after the other As a result two more short run total cost curve are added to STV1 in the manner shown by STC2
and STC3, the LTC can now be drawn thought the minimum point of STC1, STC2 and STC3 or LTC
commodity curve .

STC3 LTC
STC2
STC1
Total cost

Q1 Q2 Q3
Output
Long Run Average Cost Curve (LAC)- Long run average cost LAC is derived by combining the short run
average cost curve SAC . There is one SAC associated with each STC the firm has a series of SAC curve
each having a bottom point showing the minimum SAC. For instinct C1 Q1 is minimum when the firm has
only one plant. The AC decrease to C2 Q2 when The second plant them rise to C3 Q3 after the addition of then
other Plant. The LAC curve can be drawn through ………..SAC1, SAC2, and SAC3..

SAC1 SAC2 SAC3 LAC

C1 C3
C2
Average cost

Q1 Q2 Q3

MONOPOLISTIC

Monopolistic competition - monopolistic competition is defined as market setting in which a large number
of seller sell differentiated product.

Feature of monopolistic-
• Large no. of seller and buyer
• Free entry and free exist
• Differentiated product
• Non-price competition
• Presence of selling cost
• More elastic demand curve

Some facts about monopolistic compelition -

• Elasticity of demand is more then unit, since the availability of close substitutes.
• Firm have some control overt the price of the product
• Price elasticity of demand of an individual firm is large but not infte
• AR>MR and they are both down ward slopping curve
• AR and MR curve are down word slopping but flalter as compared to monopoly become the
presence of close substitute
• In the long run the firm can earn only normal product

Price and output decision in short run- the AR>MR and demand curve is more elastic then monopoly or
more number of substitute avilaileble.

AR and
MR
AR

MR
Quantity →
Cost Curve – both the AC and MC are of ‘U’ shape because of low variable proportion.

MC
AC

Ac
And
Mc

Quantity →

Short period is a period of time where time is inadequate to make all sort of changes and adjustment in the
productive process. The equilibrium price and output is determined at the point where short term marginal
cost equals marginal revenue. the rate of profit would not be the same for all the term under monopolistic
competition because of difference in the elasticity of demand for their product , some firm may earn only a
abnormal profit , normal profit or loss as per treir revenue curve.
SMC

SAC
AR B C
& A D
MR AC

Quantity E MR

Profit is maximum when MR=MC

Profit = TR- TC
= OBCE-OADE
=ABCD
Price – Output. Determination In The Long Term –
Long term is a period of time where a firm will get adequate time to make any change in the productive
process or business. in long run a firm can earn only normal profit if AR>AC= super normal profit this leads
to entry of new firm – increase instant total number of firm – total production – fall in price decline in profit
rates on the other hands , if AC is greater than AR, there will be losses this leads to exit of old firm decrease
in the number of firm – total production – rise in price increase in profit rate then the entry and exit and of
firm continue all AR became equal to AC term in the long run we have a MR = MC and AR=AC

LMC

LAC
Price
Price

AR

AR

Output (quantity) →

PERFECT COMPETITION

Perfect competition is a state of market in which there is a large number of buyers and sellers selling
homogenous product.

Features of perfect competition:

• Large number of buyers and sellers.

• Homogenous products.
• Free entry and free exit of the firm.
• Prefect knowledge of the product.
• Perfect mobility of factor of productions.
• Absence of advertising or selling cost.
• Price is assumed to be same every where.
• Existence of single price.
• Full and unstructured competition.
• Normal profit.
• Absence of collusion.

Some facts about perfect competition:

• Firm have not control over the price of the product.

• Price elasticity of demand for an individual firm is infinite.
• AR=MR and remain constant for different level of output.
• Price is lower then in monopolistic competition.
• A firm is price taker and industry decide price.
• Firm charge uniform price from all buyer there is no price discrimination.
• In the short period , a firm can earn abnormal profit but in the long run earn only normal profit.
• In short run , manager of firm should shut down the operation if price is below average variable cost.
• If price is greater than average variable cost but less than average cost the firm should continue to
produce in the short run.
Price – output determination under perfect competition in short run :

Revenue Curve:-
In perfect competition, the industry is the price maker and firm is the price taker. A firm has to accept the
price as fixed by the industry since price demand same and constant in perfect competition, we have
Q P TR MR AR
1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10

Price AR=MR

Quantity

Cost Curve:-

The curve of MC and AC both are of “U” shape because low of variable proportion.
MC
AC

cost

Quantity
Now, In the short run, it is possible to increase the supply by increasing the variable inputs, supply curve in
elastic.

AR=MR=Price

AR=MR=Price

Profit is maximum, when MR=MC, hence

Profit = TR – TC
= OBCE – OADE
= ABCD
The firm in perfect competition maximizes profit by producing at the rate of output where the price equals
marginal cost.
In the short run, manager of a firm should shut down the operation if price is below average variable cost.

If the price is greater than average variable cost but less than average the total cost, the firm should continue
to produce in the short run because a contribution can be made to fixed cost.

Price – output determination in long run:

In the long run, a firm can adjust their size according to the industry and new firm can enter the industry.

A firm is in profit if AR>AC

Equilibrium AR=AC
Loss if AR<AC
In long run a firm can earn only normal profit. It is very difficult to make abnormal profit in the long run
because other will enter in the industry that forces to decrease the price.

• A monopolistic firm can earn abnormal profit both in the short run and long run.
• Price is higher and output is smaller than perfect competition.
• Price elasticity of demand is very small.
• AR and MR curves are downward slopping and steeper showing inelastic demand because no close
substitutes are present.
• In the long run the firm can earn super normal profit.

Price – output determination in short run:

Revenue curve:-
TR = P.Q

Q P TR AR MR
1 10 10 10 -
2 9 18 9 8

3 8 24 8 3
4 7 28 7 4
5 6 30 6 2
6 5 30 5 0
7 4 28 4 -2
 • AR will not touch X axis, because price cannot be zero.
• TR is maximum when MR = 0.
• TR start declining when MR become negative.

MONOPOLY

Monopoly is that market form in which a single producer controls the whole supply of a single commodity
which has no close substitutes.

Features of monopoly

• Single seller.
• No close substitute of the commodity.
• Difficult entry of a new firm.
• No competition.
• Control over supply.
• Price maker.
• Firm and industry is same.

Some facts about Monopoly:

• A monopolist is a price maker and not a price taker.

• Price discrimination is possible.
• Demand curve is relatively inelastic. The demand curve slope downward

Cost Curve:
Both AC and MC curve are of “U” shape because law of variable
proportion.
MC
AC

In short run pricing and output decision under monopoly and based on revenue and cost condition. Although
AC and MC curve in monopoly market are generally identical. Revenue condition differs because a
monopoly firm faces a downward sloping curve as elasticity of demand is less than one. The slope of the
MR is twice that of AR.
Profit is maximum when MR = MC
Profit: - TR – TC
OBCE – OADE
ABCD

If AR > AC → Economic Profit

AR = AC → Normal Profit
AR < AC → Losses

Price – output determination in long run:

In long run, the monopolist produces longer output and charges a lower price and makes a longer monopoly
profit in the long run. In the short run equilibrium price is greater than the long run equilibrium price.

The monopoly firm in the long run will continue its operation till its reaches the equilibrium point where
long run MR equals long run price. The price changes at this level is called equilibrium price. In monopoly
price is greater than AC MC and MR.
Oligopoly: -

Oligopoly is a market situation in which there are a few (but more than two) firms selling homogeneous on
differentiated but close substitute products. Thus there can be two kinds of oligopoly.
1.) Homogeneous oligopoly

2.) Heterogeneous oligopoly

Characteristic of Oligopoly Market: -

➔ It is interdependence in decision maker

➔ Small number of large firm

➔ Either homogeneous or heterogeneous products

➔ Price rigidity

➔ Indeterminateness of the demand curve

➔ Existence of kinked demand curve

➔ Few seller