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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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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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