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
