Costs, Revenues, & Profits

Concepts of costs and revenues; How to maximize profits;

The following notes are the basic concepts in the mainstream (Capitalistic, neo-classical) Economics.

Costs

  • Total Costs (TC) = Fixed Costs (FC) + Variable Costs (VC)
  • The Law of Diminishing Returns
    • Marginal Product (MP) = change on total output ⁄ change in the variable factor
    • Productivity will be reduced whenever the additional variable factor is added
  • Marginal Costs (MC) = change in TC ⁄ change in output
    • MC is the inverse of MP; each additional factor lead to the more cost
  • Average Costs (AC)
    • TC = FC + VC
    • AC = TC ⁄ Q = FC ⁄ Q + AC ⁄ Q = Average Fixed Costs (AFC) + Average Variable Costs (AVC)
  • MC vs. AC
    • MC > AC: pull AC up
    • MC < AC: bring AC down
    • MC will cross AC at the AC’s minimum point

Long-run Costs

  • Economies of Scale
    • The company can reduce the AC when it produces more.
  • Diseconomies of Scale
    • If the company grows too large, it may find the AC begin to rise again.
  • Minimum Efficient Scale (MES)
    • The first point of output at which the long-run AC is minimal.

Revenues

  • Total Revenue (TR): the measurement of the sales
    • Tr = Price (P) × Quantity (Q)
  • Marginal Revenue (MR): the difference in Total Revenue when an additional unit is sold
    • MR = change in TR ⁄ change in Quantity

Profit

  • Profit = Total Revenue (TR) – Total Costs (TC)
  • Profit Maximization
    • A company should stop producing at the point where Marginal Revenue (MR) equals Marginal Costs (MC)
    • MR > MC: extra unit will make a profit
    • MR = MC: no extra profit
    • MR < MC: extra unit will be a loss

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