FLYING

FIRMS CO LO U R S

• Cost, Revenue & Objectives

• Market Structure: Competition & Monopoly
• Business Structure or Types of Business Organisation
Costs of production
• Cost of production is the sum of expenses that firms face while procuring
factors of production to produce goods and services.
• Firms usually assess costs in two time periods and these are:
1. Short run: a time period in which firms can change its variable factors
to increase or reduce the level of output produced while at least one
factor of production remains fixed. In other words, in the short run
firms operate with a fixed factor and can only change variable factors.
2. Long run: a time period in which firms can change all factors of
production, including the fixed factor, to either increase or reduce
output. (*recall economies/diseconomies of scale). In the long run
firms can change its scale of production.
Short run costs
• Fixed cost: also known as indirect costs or overheads are the
expenses a firm incurs in procuring the fixed factors i.e. factors of
production which can not be changed in the short run. These costs
do not change with changes in the level of output produced by a
firm and remains constant over a relevant range of output (i.e.
over a scale of production). Examples: rent, insurance,
subscription fees, interest on loans etc.
• Variable cost: also known as direct or prime costs are expenses a
firm incurs in procuring variable factors of production i.e. factors
of production which change directly with changes in output levels.
Examples: cost of raw materials, electricity bills etc.
Fixed cost diagram
Cost ($)

100 Total Fixed Cost

Output
10 20 30
Variable cost diagram
Cost ($) Total Variable cost

120

80

40

Output
10 20 60
Total cost
• A firms total cost is the sum of its total fixed cost and total
variable cost for a given level of output.
• TC = TFC + TVC
• Since total variable cost is zero when output is zero, total
cost must then be equal to total fixed cost.
• TC = TFC + 0
• Therefore, at zero output, TC = TFC
Total cost Diagram
TC TVC
Cost ($)

C
TF

100 TFC

Output
Average Cost
• Average cost (AC) or Average Total Cost (ATC) is the cost per
unit of output i.e. the cost of producing each unit of output.
• AC = TC/Q alternatively AC = AFC + AVC
• Average variable cost is the variable cost of producing each
unit of output.
• AVC = TVC/Q
• Average fixed cost is the fixed cost per unit of output or the
fixed cost of producing each unit output.
• AFC = TFC/Q
Average Fixed Cost curve
Cost ($) Average fixed falls continuously with an increase in output

50

25

12.5
AFC
Output
2 4 8
Average Variable Cost curve
Cost ($)
AVC

50
47.5 The curve is U shaped due
45 to increasing and
diminishing returns

Output
10 15 40
Average Total Cost curve
Cost ($)
• AC = AFC + AVC
• AFC = AC - AVC AC
AVC

AFC

Output
Revenue
• A firms total revenue or total income is the sum of the total
receipts from the sales of output.
• Therefore, total revenue is the product of price and total
amount of output sold.
• TR = P × Q
• Average revenue is the revenue earned from the sales of
each unit of output.
• AR = TR ÷ Q
• Therefore, it follows that AR = P since P = TR ÷ Q
Total Revenue curve
TR
Revenue ($)

15

10

Output
20 30
Profit
• Profit is the positive difference between a firms total
revenue and its total cost.
Revenue($) TR
Breakeven point

r ofit
P TC

at Q units, TR = TC
ss
Lo

Output
Q
Objectives of firms
Profit Maximisation : A firm maiximising profits produces a level of output at which
the positive difference between a firm’s total revenue and the firm’s total cost is
maximum.
Revenue/Cost($)

TC

TR

Output
Q
Revenue/Sales revenue maximisation
• A firm maximising revenue produces a level of output at which the firms total
revenue is at its maximum. In other words, when the firms total income
(distinguish it from profits) is maximised.
Revenue/Cost($) Notice that
revenue
maximisation takes
TC place at higher
level of output
compared to profit
maximisation.
TR

Output
Q QR
Profit maximisation vs. Revenue maximisation
Profit maximisation Revenue maximisation
Higher retained profits to finance future Increased sales as price is lowered
investments and expansion helping to gain market entry
Greater returns to share holders or Increase in market share helps to
higher wages paid to workers exercise more power in the long run
Investments in R&D can be increased Increased output can help firms reap the
benefits of economies of scale
Retained profits can help firms to Firms charge a lower price and this can
withstand unexpected economic events enable firms to compete out rivals.
Other objectives
• Profit satisficing: producing a level of output that yields enough
profits to satisfy the shareholders or owners of the business. This
objective is often set by firms in which there is a divorce between
ownership and control. Due to this separation owners and
managers might have conflicting aims or objectives. In such
circumstances, managers often generate profits that keeps
owner’s happy instead of setting the objective to profit
maximisation.
• Social welfare: some firms move away from conventional
objectives and often engage in activities that benefits the society
as a whole. State owned firms have a tendency to operate with
such objectives. For example, a state owned firm might focus
more on creating sustainable employment opportunities rather
than setting conventional objectives.
Market Structures
Perfect competition vs. Monopoly
Perfect Competition Monopoly
1. Large number of producers. 1. Single producer or one producer
2. Large number of consumers. has more than 25% of the market
3. Low or no entry/exit barriers. share while others a small firms.
4. All firms and consumers are price 2. Large number of consumers.
takers i.e. they accept the price 3. High entry/exit barriers.
decided by the market. 4. Producers are price makers i.e. they
5. Products are perfect/close can control price or output.
substitutes of each other. 5. Products do not have any close
6. Existing firms can only make substitutes.
normal profits in the long run. 6. A monopolist makes supernormal
7. Firm’s only objective is profit or abnormal profits in the long run.
maximisation. 7. Firm can have alternative
objectives such as revenue or sales
maximisation.
Evaluating competition
Advantages Disadvantages

• Consumer’s enjoy low product • Firms fail to enjoy economies of

price. scale and are high cost producers
• Consumer’s enjoy a wider choice. charging higher price.
• Products are standardised across
• Competition regulates the firms all producers and hence no true
and no form of government variety is enjoyed by consumers.
interference is required. • Too much competition and the
• Firms use resources efficiently inability enjoy economies of scale
preventing resource can mean resource overuse or
misallocation or wastage. wastage.
• Firms do not compromise with • Firms fail to invest in R&D and
product quality as it can mean a product innovation rate falls
overtime.
loss of market share.
Evaluating Monopoly
Advantages Disadvantages

• Monopoly enjoys economies of scale and • Single producer devoid of competition

passes on the cost saving in the form of low might prioritise profits and to achieve it, is
price. likely to restrict output and charge a high
• Monopoly enjoys supernormal profits and price.
invests it in R&D to innovate both products • With competition absent and consumers
and production process. Consumers enjoy deprived of choice, monopoly might
improved products over time. exploit the situation by providing low
• Monopoly survives by preventing entry of quality goods.
new firms. This might encourage them to • Absence of competitive threats might
keep prices low while not compromising also discourage monopoly firms from
product quality. investing in R&D. This can lead to
• Profits made by monopoly firms allow these inefficiency and wastage of resources.
to survive when economic conditions are
unfavourable. Such firms thus ensure stable
supply of goods.