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Module 5 The Theory of Cost and Profit

The document discusses the theory of cost and profit. It defines key terms like costs, assets, and profit. It differentiates between economic and accounting costs. It also distinguishes between fixed and variable costs. The document analyzes costs in the short run versus the long run. It discusses how to compute profit by taking the difference between revenue and costs. It provides examples of computing average, total, and marginal costs. Finally, the document demonstrates how to analyze profit in the short run and long run.

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Charice Anne Villamarin
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403 views22 pages

Module 5 The Theory of Cost and Profit

The document discusses the theory of cost and profit. It defines key terms like costs, assets, and profit. It differentiates between economic and accounting costs. It also distinguishes between fixed and variable costs. The document analyzes costs in the short run versus the long run. It discusses how to compute profit by taking the difference between revenue and costs. It provides examples of computing average, total, and marginal costs. Finally, the document demonstrates how to analyze profit in the short run and long run.

Uploaded by

Charice Anne Villamarin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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The Theory of Cost and Profit

Objectives: • Describe the concept of the theory


of cost and profit
• Differentiate economic costs and
accounting costs
• Distinguish Fixed Costs and Variable
Costs
• Analyze short-run and long run costs
• Compute profit
Terms to Remember

Assets- a resource that has economic value owned by individual or


company

Cost- value of money that has been used up to produce something

Profit- the positive net effect or the difference between revenue


and cost

Imputed Costs- cost that is implied but not included in financial


report or accounting record

Opportunity Cost- deals on how much more (less) one gains in giving
up alternatives to benefit from a choice
Economic Cost
• Sum of opportunity costs of market-supplied resources
Lesson 1: plus opportunity costs of owner-supplied resources.

Cost Concept Accounting Cost


• Costs that are properly recorded
Short- run for a firm is the time horizon
when one input is held constant
Short-run Types of short- run costs:
▪ Total Fixed Costs
analysis ▪ Total Variable Costs
▪ Total Costs
▪ Average Fixed Costs
▪ Average Variable Costs
▪ Average Total Costs
▪ Marginal Costs
TC = ATC (Q)

Total Cost TFC = AFC (Q)

TVC = AVC (Q)


ATC =TC/Q

Average AFC =TFC/Q


Cost

AVC= TVC/Q
Marginal Cost=
ΔTC/ΔQ
Marginal Output = Change in Total Product
Change in Input

Marginal Input = Change in Input ___


Change in Total Product
Long-run for a firm is a time period
wherein all fixed factors can be
variable
Long-run
analysis • Long-run average total cost (LAC)- the curve
tangent to each short-run average cost
representing different plant sizes that a firm
can build in the long-run

• Long-run marginal cost measures the change in


long-run total cost from a given change in
output
• Long-run average total cost (LAC) of producing
Long-run a given level of output is always the lowest
analysis point of the short-run ATC of producing that
output
• Long-run marginal cost is U shaped and reaches
its minimum point before the LAC curve
reaches its minimum just like in the short-run
analysis. At the increasing portion of the LAC,
LMC is over LAC.
Lesson 2:
Profit Analysis
Revenue

AR= MR=
TR = PQ
TR/Q ΔTR/ΔQ
PROFIT

Profit = TR-(TFC + TVC) Profit=(TR-TVC)-TFC


TR>TC= there is a profit

TR<TC= there is a loss


Profit Analysis
TR=TC -> break-even
In a competitive firm, if it
wants to maximize profits, the
optimum level of production in
the short-run is when:

Profit in the Short-


run

MARGINAL COST = PRICE


Profit Analysis
If P> ATC, there is a profit

If P=ATC, Profit is zero

Even if P<ATC, the firm may still continue in the short-run if P>AVC

If P=AVC or P<AVC, the firm should shutdown


ABC COMPANY
Income Statement
For the Year Ended: December
2019

Sales 7,000,875.00
Less: Cost of Goods Sold
Raw Materials 4,000,504.00
Direct labor 371,580.00
Factory Overhead 385,520.00 4,757,604.00
Gross Profit 2,243,271.00
Less: Operating Expenses
Other Salaries and Wages 795,000.00
Rent 20,900.00
Gasoline and Oil 37,600.00
Repairs and Maintenance 49,500.00
Utilities 24,800.00
Office Supplies 10,000.00
Taxes 35,000.00
Insurance 40,000.00
Depreciation 3,000.00
Miscellaneous 5,000.00 1,020,800.00
Net Income from Operation 1,222,471.00
Less: Other Expenses
Interest Expense 41,078.00
Net Accounting Profit 1,181,393.00
Less: Opportunity Costs
Alternative Employment Earnings 28,000.00
Alternative Earnings of Capital 70,000.00 98,000.00
Net Economic Profit 1,083,393.00
References

• Gabay, Bon Kristoffer G, Remotin, Jr. Roberto M, Uy, Edgar


Allan M. (2010) ECONOMICS: Its Concept and Principles,
Manila, Rex Bookstore, Inc.
• Pagoso, C. M, Dinio, R.P., Villasis, G.A., Meneses, P.P.,
Veloso, P.P.(2015) INTRODUCTORY MICROECONOMICS
Fourth Edition, Manila, Rex Bookstore, Inc.
• Mankiw, Gregory Principles of Economics, Cengage South-
Western

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