THEORY OF COST AND

PROFIT
COST CONCEPT
- a firm maintains a stock of assets that it can use for
production.

TWO CLASSIFICATIONS OF ASSETS

1. Real Assets machineries, buildings, materials and
supplies.
2. Monetary Assets forms of money and near
money, part of which the firm transforms into real
assets through purchases or acquisitions.
OPPORTUNITY COST
Is the foregone opportunity of choosing an
alternative. The difference between the opportunity
gained from the alternative and its opportunity cost
is the net gain (loss) from said choice. Simply put, it
is how much more (less) one gains in giving up
alternatives to benefit from a choice.
 IMPUTED COST
Cost that is implied but not included in financial report
or accounting record.
Examples:
Imputed salary of the entrepreneur who doubles as the
general manager of the business.
Imputed rent for the use of personal properties for
production.
Interest income for opportunity of using owners money.
COST-OUTPUT RELATIONSHIP IN
SHORT RUN
Certain level of optimum input and maximum
output, cost-output relationship assumes
different forms. These are the short-run cost
functions since plant size and capacity are
fixed.
 FIXED AND VARIABLE COST
Total Cost (TC) has two basic components namely: fixed cost and
variable cost.
Total Fixed Cost (TFC) does not vary with output; whereus, total
variable cost (TVC) varies in direct proportion. The following
equation illustrates:
TC = TFC + TVC
Where:
TC = Total Cost
TFC = Total Fixed Cost
TVC = Total Variable Cost
 MARGINAL COST
The
following are the marginal cost concepts with the equations that
define them:
MC = =
MVC =
Therefore, MC = MVC since TFC is constant and TVC is the only
component that causes TC to change.
Where: MC = Marginal Cost or change in total cost
MVC = Marginal Variable Cost or change in Total Variable Cost
Q = Quantity of Output
= Infinitesimal Change or a unit change that is infinitely small
TOTAL AND MARGINAL COST FUNCTION

Therefore:
 AVERAGE COST
Average
cost is the cost per unit of output which assumes the
following term:

Where: ATC = Average Total Cost or cost per unit of output

TC = Total Cost
Q = Quantity of Output
AFC = Average Fixed Cost or fixed cost per unit of output
TFC = Total Fixed Cost
AVC = Average Variable Cost or variable cost per unit of output
TVC = Total Variable Cost
THE AVERAGE COST FUNCTION
 PROFIT CONCEPT

TOTAL
AND MARGINAL REVENUES

The following are the concepts of revenue-output relationship with

the equations that define them:
TR = PQ
(whether price is constant or not)
M
M
M
where: TR = Total Revenue
AR = Average Revenue or revenue per unit of output
MR = Marginal Revenue or revenue per additional unit of output
P = Price
Q = Quantity
= Infinitesimal change
 MAXIMUM PROFIT AND MARGINAL
APPROACH
Profit is defined as Total revenue (TR) less Total Cost (TC) with Total
Variable Cost (TVC) and Total Fixed Cost (TFC) as the latters
components. The profit function is alternately expressed as follows:
Profit = TR (TFC + TVC)
= (TR - TVC) TFC
Since TR and TVC are the sums of their marginal values (MR and MC)
and TFC is fixed, the profit function is further expressed as follows:
Profit = (MR-MC)+TFC
= (MR-MC)-TFC
THE MR AND MC CURVES
PRICE AND NUMBER OF
SELLERS
The volume that a seller is willing to
sell at a certain price level is his
maximum profit output or supply.
PRICE CHANGE AND MAXIMUM PROFIT
PRODUCTIVITY AND TECHNOLOGY
An increase/decrease in the overall productivity
level due to technological changes expands/ limits
productivity capacity. This is due to an
increase/decrease in the capacity to produce per
unit of input as reflected in the marginal and
average product.
THE MAXIMUM PROFIT POINT
COST OF
PRODUCTION
An increase in the prices of variable inputs
increases the mc, TVC, AVC and ATC. This
increase in cost is not associated with plant
expansion and therefore cost changes but not
maximum output.
SHUTDOWN PRICE