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Eco - MMS - Chapter - 7
Eco - MMS - Chapter - 7
MANAGERIAL ECONOMICS
FOR MMS
PROF. KAZI
[email protected]
9820490844
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SUBJECT : MANAGERIAL
ECONOMICS
Chapter CONTENTS
1) INTRODUCTION
2) CONSUMER BEHAVIOUR - I
3) CONSUMER BEHAVIOUR - II
4) SUPPLY/EQUILIBRIUM PRICE
5) PRODUCTION FUNCTION
6) RETURNS TO SCALE
7) REVENUE AND COST
8) TYPES OF MARKET
9) PRICING PRACTICES
10) PROFIT MANAGEMENT
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11) CAPITAL BUDGETING
CHAPTER SEVEN – REVENUE AND
COST ANALYSIS
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REVENUE AND COST ANALYSIS
CONTENTS:
(A) SHORT RUN COST FUNCTION
(B) LONG RUN COST FUNCTION
(C) REVENUE CONCEPT
(D) BREAK EVEN ANALYSIS
(E) QUESTIONS/ASSIGNMENTS
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(A) SHORT RUN COST FUNCTION
A short run cost function is one in which some cost are fixed and some cost are
variable. Thus there are two types of cost namely
(1) Fixed Cost
(2) Variable Cost
Fixed costs are the cost which are incurred on fixed factors. Example land,
building, machine. Fixed cost remains fixed whatever may be the level of
output.
Thus when output is zero fixed cost is not zero.
Variable cost refers to the cost which are incurred on variable factors.
Example labour and raw material. Variable cost varies directly with output. It
rises with a rise in output and falls with a fall in output. When output is zero,
variable cost is zero. This can be seen from the following figure. 5
(A) SHORT RUN COST FUNCTION
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(A) SHORT RUN COST FUNCTION
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(A) SHORT RUN COST FUNCTION
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(A) SHORT RUN COST FUNCTION
(5) AVC is the variable cost per unit of output. For example labour cost
per unit or raw material cost per unit. It is calculated by dividing variable cost
by total output.(AVC=VC/output).
AVC in the beginning declines marginally and then it goes on increasing
continuously as output increases. It declines because of the initial economies in
operations and it rises because of the rise in variable cost. The shape of AVC
can be seen from the following figure.(Refer slide number 09)
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(A) SHORT RUN COST FUNCTION
(6) AC is the total cost per unit of output.It is calculated by dividing total cost
by total output.(AC=TC/Output or AC= AFC+AVC)
AC goes on diminishing up to a point and then it goes on increasing. Thus AC is
U shaped.
(7) MC is the cost of producing one more unit of output or it is the net addition
to the total cost. For example when ten units are produced and TC is Rs 100 and
when eleventh unit is produced the TC becomes 120 then marginal cost is Rs
20.MC goes on diminishing upto a point and then it goes on increasing.Thus MC
is also U shaped.
The relationship between AC and MC can be explained with the following
figure:
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(A) SHORT RUN COST FUNCTION
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(A) SHORT RUN COST FUNCTION
It can be seen from the above figure that AC and MC both have U shape.( first
decline, reaches minimum and then goes on increasing).
When AC is falling, MC is also falling but MC is less than AC.It means additional
cost goes on diminishing. Thus it is profitable for a firm to produce more and
more.
When AC is rising, MC is also rising but MC is higher than AC. It means
additional cost goes on increasing. Thus it is less profitable for a firm to produce
additional output.
MC cuts AC at the lowest point. A firm will go on producing till its AC becomes
the least. This point is called profit maximisation point for a firm. This firm is
called optimum firm.( A firm which produces maximum output at the minimum
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EXAMPLE: Complete the following table:
(A) SHORT OUTPUT FC VC TC AFC AVC AC MC
RUN COST 0
1
200 0
200 5
FUNCTION 2 200 10
3 200 18
4 200 28
5 200 45
6 200 70
7 200 100
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(A) SHORT RUN COST FUNCTION
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(B) LONG RUN COST FUNCTION
In the long run cost function all costs are variable. There is no difference
between the fixed cost and the variable
cost. In other words in the long period a firm can go on changing its capacity and
adjust supply as per the market conditions.
The long run cost function can be seen from the following figure:
Initially the firm operates on short run average cost curve number one or the first
plant.It produces OB output and its AC is BQ. Now when the firm produces
more output on the same plant, the AC goes on increasing from BQ to CJ.
Therefore to cut the cost the firm operates on another plant SRAC 2.Now the
same output can be produced at a much lower cost ie CK. Thus there is saving in
cost by KJ. This process continues and we can derive the long run average cost
by joining the mid points of all short run cost curves. This can be seen from the
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(B) LONG RUN COST FUNCTION
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(B) LONG RUN COST FUNCTION
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(B) LONG RUN COST FUNCTION
Thus when we join all the mid points of short run average cost curves we get
long run average cost curve. The long run average cost curve is also U shaped
but it is much flat than short run average cost curve. It means a firm in the long
run can produce higher output at lower cost than in short run.
In other words long run output is higher than short run output and long run cost
is lower than short run cost.
The reasons for the U shaped average cost curve in the long run can be
explained in terms of economies and diseconomies of scale. The long run
average cost is also called planning curve or envelope curve.
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(C ) REVENUE CONCEPTS
CONCEPTS UNITS
1
TR
100
MR AR
2 125
3 170
4 220
5 300
6 400
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(D) BREAK EVEN ANALYSIS
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(D) BREAK EVEN POINT
Example: Calculate break even point in units, sales and percentage from the
following data:
Fixed Cost Rs 30000
Variable Cost Rs 60000
Total Revenue Rs 120000
Total output 10000
First calculate selling price per unit and variable cost per unit. Selling price per
unit is calculated by dividing total revenue by total output ( 120000 divided by
10000 = Rs 12) Similarly variable cost per unit is calculated by dividing variable
cost by total output ( 60000 divided by 10000 = Rs 6)
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(D) BREAK EVEN POINT
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(D) BREAK EVEN POINT
Example : Calculate break even point in units, sales and percentage from the
following data:
Fixed Cost Rs 100000
Variable Cost Rs 200000
Total Revenue Rs 400000
Units 10000
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(D) BREAK EVEN POINT
Applications of BEP:
The various applications of break even point to business can be seen as below:
(1) Useful in evaluating investment projects:
BEP is useful in evaluating investment projects or capital projects. Those
projects are considered to be good or feasible in which the BEP is low.
Generally lower the BEP, higher will be the profitability of the project or higher
the BEP, lower will be the profitability of the project. This can be seen from the
following figures.
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(N) BREAK EVEN POINT (contd.)
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(D) BREAK EVEN POINT
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(D) BREAK EVEN POINT
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(D) BREAK EVEN POINT
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(D) BREAK EVEN POINT
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(D) BREAK EVEN POINT
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(N) BREAK EVEN POINT
LIMITATIONS OF BEP:
(1) Not the only method of evaluating capital project.
(2) Cannot be easily calculated when firm produces many products.
(3) Assumes that FC,VC,SP remain constant during the process.
(4) Does not cover quality of the product.
(5) Does not provide data on the timing and magnitude of cash flow.
(6) Some cost are not easily divisible due to interdependency of
production.
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(E ) QUESTIONS/ASSIGNMENTS
(9) When FC is Rs 1000 and VC per unit is Rs 5 and selling price per unit is Rs
10 then break even point will be -------------
(a) 100 units (b) 150 units (c ) 200 units (d) 300 units
(10) ---------- refers to the difference between break even sales and actual sales.
(a) Safety margin (b ) Break even point (c ) Selling price (d) ROI
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(E) QUESTIONS/ASSIGNMENTS
Q1 Describe short run cost function (or behaviour of short run cost curves like
FC,VC,TC,AFC,AVC,AC and MC.
Q2 Describe with suitable diagram long run cost function.
Q3 Describe briefly the different revenue concepts (or AR,MR and TR)
Q4 Define break even point and show with the help of suitable diagram.
Q5 Discuss the managerial uses of break even point.
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(E ) QUESTIONS/ASSIGNMENTS
1 A buyer from Mexico wants to buy from your company. He wants a discount
of 10 % on the price quoted by you. Your price include profit margin of only
10%.How you will deal with this case.
2 Collect data on the cost break up of any suitable product of your choice.
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