Cost revenue and profit maximization
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Cost, Revenue, and Profit Maximization. Chapter 5, Lesson Five. The Purpose of a Business. What is the purpose of a business? If you are a business owner, what do want? Hopefully you said to make the most money possible. How do we make money?

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Cost, Revenue, and Profit Maximization

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Cost revenue and profit maximization

Cost, Revenue, and Profit Maximization

Chapter 5, Lesson Five


The purpose of a business

The Purpose of a Business

  • What is the purpose of a business?

  • If you are a business owner, what do want?

  • Hopefully you said to make the most money possible.

  • How do we make money?

  • We earn more than we spend. There are a few terms that economists use to explain this very simple idea.


Costs

Costs

  • A business must analyze costs before making decisions.

  • To simplify decision making, cost is divided into several different categories.

  • Fixed cost—cost of business incurs even if the plant is idle and output is zero

    • -In other words, how much it costs you to have the company even if you aren’t producing anything

    • Examples: salaries (not hourly pay), rent, property taxes, car notes

    • Usually associated with machines, equipment, buildings, etc.


Costs1

Costs

  • Variable costs—costs that change when the business rate of operation or output changes

    • Costs that change according to how much you produce

    • Examples: wages (per hour), electricity bill, freight/shipping charges

    • Usually associated with labor and raw materials


Costs2

Costs

  • Total cost (or overhead)—the sum of the variable and fixed costs

  • Marginal Costs—extra cost incurred when a business produces one additional unit of product.

  • MC = difference in total costs / marg. Prod.

    • Fixed costs do not change—marginal cost is the per unit increase in variable costs that stems from using additional factors of production.


Revenue makin money

Revenue (Makin’ Money)

  • We want to make more than we spend. We’ve already looked at what we spend (costs), now we need to look at the amount of money we pull in (revenues).

  • Total Revenue—total amount of money that comes into the business

    # of units sold multiplied by average price per unit

    Or quantity sold multiplied by price per unit


Revenue

Revenue

  • Marginal revenue—extra revenue associated with the production and sale of one additional unit of output

    MR = difference in total revenue / marg. Prod.


Marginal analysis

Marginal Analysis

  • Economists use marginal analysis, a type of cost-benefit decision making that compares the extra benefits to the extra costs of an action.

  • This analysis will show us when we are losing money, when we are making money, and when we are breaking even.

  • Break-even point—total output or total product the business needs to sell in order to cover its total costs.


Marginal analysis1

Marginal Analysis

  • A business wants to do more than just cover its costs and break even.

  • It wants to make money! That’s the goal of a business.

  • We want to minimize our costs and maximize our revenues to find the point that will make use the most amount of money


Profits

Profits

  • Profit—your revenue minus your costs (how much is left over after you pay your bills)

  • Total profit—Total revenue minus total costs

  • The total profit is maximized where marginal costs equal marginal revenue. This is were business should operate to make the most possible money.

  • This is where they are not missing any would be profits and they are not losing any money.


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