MODULE 2 Key Measures and Relationship
 Loss or negative profit
A. Revenue, Cost, and Profit
- Most businesses sell something—either a
physical commodity like an ice cream bar or a
service like a car repair. In a modern economy,
that sale is made in return for money or at least
is evaluated in monetary terms.
Revenue
- The total monetary value of the goods and
services sold
Revenue = No. of Units Sold x Average Price
Cost
- The collective expenses incurred to generate
revenue over a period of time, expressed in
terms of monetary value.
 Variable cost
- expense that changes in proportion to
how much a company produces or sells.
- increase or decrease depending on a
company's production or sales volume
- they rise as production increases and
fall as production decreases.
- Costs where as sales go up, expenses go
up
 Fixed cost
- expense that doesn’t change even with
an increase or decrease in the number
of goods and services produced or sold.
- It is commonly related to recurring
expenses not directly related to
production, such as rent, interest
payments, and insurance.
- are largely invariant to the volume of
sales, at least within a certain range of
sales volumes
Fixed Cost + Variable Cost = Total Cost
Profit
- Businesses are viable on a sustained basis only
when the revenue generated by the business
generally exceeds the cost incurred in operating
the business.
- The difference between the revenue and cost
- When costs exceed revenue
EXAMPLE
Suppose three students like spending time at the beach.
They have pondered whether they could work and live at
the beach during their summer break and learned that
they could lease a small building by the beach with
existing freezer capacity and apply for a local license to
sell ice cream bars.
They met the person who operated an ice cream bar
business in this building the previous summer. He told
them last summer he charged 1.50 per ice cream bar and
sold 36,000 ice cream bars. He said the cost of the ice
cream bars—wholesale purchase, delivery, storage, and
so on—comes to about 0.30 per bar. He indicated his
other main costs—leasing the building, license, local
business association fee, and insurance—came to about
16,000.
REVENUE 1.50 per ice cream bar x 36,000 ice
cream bars = 54,000
VARIABLE 0.30 per ice cream bar x 36,000 ice
COST cream bars = 10,800
FIXED COST Leasing the building, license, local
business association fee, and
insurance = 16,000
PROFIT Revenue – Total Cost = 54,000 –
26,800 = 27,200
B. Economic Versus Accounting Measures of Cost and
Profit
Explicit costs
- are out-of-pocket costs for a firm
- for example, payments for wages and salaries,
rent, or materials.
Implicit costs
- are a specific type of opportunity cost: the cost
of resources already owned by the firm that
could have been put to some other use.
 - For example, an entrepreneur who owns a
business could use her labor to earn income at
a job.
Accounting costs
- are explicit costs, also referred to as hard costs
- include business necessities like payroll,
production costs and marketing budgets.
- Businesses can easily track explicit costs
because they include specific dollar amounts.
- include anything a business spends, and you
deduct them from revenues in an accounting
period.
Economic costs
- Include accounting costs and implicit costs,
which are hypothetical expenses used when
making a business decision to forecast potential
profit.
- include both explicit and implicit costs.
Accounting profit
- has two components: fixed cost component and
variable cost component
Variable Cost
- Change with the amount produced
- Ex. cost of ingredients and wages of workers
Fixed Cost
- Remains the same regardless of the amount
produced
Fixed Cost + Variable Cost = Total Cost
Profit Function
- the difference between the revenue function
and the total cost function.
- π is used as the symbol for profit.
In the proposed ice cream bar venture, the assumption
was that 36,000 ice cream bars would be sold based on
the volume in the prior summer.
However, the actual volume for a future venture might
be higher or lower.

- revenue generated after deducting all business

costs or expenses.
- It includes explicit costs incurred when
producing a product or service, such as labor
costs, rent, utilities and maintenance costs and
the cost of materials.

Economic profit

- profit from a business' total revenue minus

costs, expenses and opportunity costs.
- next best alternative you could've chosen in a
given situation.
- It's what you lose by choosing one option over
another.
- When calculating economic profit, accountants
consider both implicit and explicit costs.

C. Revenue, Cost, and Profit Functions

Revenue Function

- The product of the price per unit times the

number of units sold

R = Price X Quantity

Cost Function
Formulas:
Approaches to find the break-even point
Revenue = price x quantity
1. Find the value of Q where the revenue function
Cost = variable cost + fixed cost and cost function have identical values
Profit = revenue – cost 1.5 𝑄 = 0.3 𝑄 + 40,000
0.3 𝑄 = 0.3 𝑄

Average cost 1.2 𝑄 = 40,000

1.2 𝑄 = 1.2 𝑄
- calculated by dividing the total cost by the
quantity Q = 33,334 units
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛
Average cost = 2. Equivalent approach
𝑛𝑜.𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑
- Find the value of Q where the revenue function
and cost function have identical values

3. Find how large the volume must be before the

average cost drops to the price level. In this
case, we need to find the value of Q where AC is
equal to $1.50. This occurs at the break-even
level calculated earlier.

4. Consider how profit changes as the volume

Average Cost = Cost / Quantity
level increases
Average cost function

- relationship between average cost and quantity Given:

Fixed Cost - ₱ 40,000

D. Break-even analysis
Price per unit - ₱ 1.50
Break-even point
Variable Cost per unit - ₱ 0.30
- The volume level that separates the range with
economic loss from the range with economic 𝟒𝟎 𝟎𝟎𝟎
Volume Sold = (𝟏.𝟓𝟎−𝟎.𝟑𝟎)
profit
Volume Sold = 33,333.3 or 33,334 units

E. Impact of Price Changes

Price per unit - ₱ 1.50

 if raised, breakeven price will drop
 if lowered, breakeven price will drop
volume requirements will change

Demand curve
- Relationship between the price charged and the
maximum unit quantity that could be sold
- is a graph that shows relationship between the
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 price charged and the maximum unit quantity
Volume sold =
𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
that could be sold
 - Follows a pattern: law of demand Notes to remember:

o The discipline of accounting provides guidelines

Law of demand for the measurement of revenue, cost, and
profit.
- Increases in price result in decreases in the
maximum quantity that can be sold
o In order to make an overall economic profit,
the business would need to accrue a sufficient
F. Marginal Analysis
number of unit contribution margins to cover
Marginal measurements the economic fixed cost.

- not only provide a numerical value to the
responsiveness of the function to changes in
the quantity but also can indicate whether the
business would benefit from increasing or
decreasing the planned production volume and
in some cases can even help determine the
optimal level of planned production
Marginal Benefit
- additional benefit that is obtained from
consuming one more unit of a good or service.
- It is important for individuals and businesses to
understand marginal benefit when making
decisions about how much of a good or service
to consume or produce
- helps to determine the optimal level of
consumption or production that maximizes
total benefit
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑇𝑜𝑡𝑎𝑙 𝐵𝑒𝑛𝑒𝑓𝑖𝑡 (𝑇𝐵)
Marginal Benefit =
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 (𝑄)
o Costs as measured according to accounting
principles are not necessarily the relevant
measurements for decisions related to
operating or acquiring a business
o If marginal revenue is greater than marginal
cost at some production level and the level can
be increased, profit will increase by doing so. If
marginal cost is greater than marginal revenue
and the production level can be decreased,
again the profit can be increased.
o Marginal measures for economic functions are
related to the operating volume and may
change if assessed at a different operating
volume level.

𝑇𝐵 1−𝑇𝐵 0
= 𝑄 1−𝑄 0

Marginal Profit

- Measures the change in profit resulting from a

unit increase in the quantity

Marginal cost
- Measures the change in cost corresponding to a
unit increase in the production level

Most profitable production level

- level where marginal profit equals zero.

Equivalently, in the absence of production level
constraints, the most profitable production
level is where marginal revenue is equal to
marginal cost