MODULE 2: KEY MEASURES AND RELATIONSHIPS
A. Revenue, Cost, and Profit
• Revenue refers to the total monetary value of goods or services sold by a
business.
• Cost encompasses the collective expenses incurred over time to generate
revenue, expressed in monetary terms.
• Variable costs fluctuate with sales volume, such as the cost of raw
materials.
• Fixed costs remain constant within a certain range of sales volumes, like
machinery costs.
• Profit is the positive difference between revenue and cost, indicating
financial success.
• Negative profit, or loss, occurs when costs exceed revenue, posing
financial challenges for businesses.
Revenue, Cost, and Profit Functions
⎯ Relationship between the volume or quantity created and sold and the
resulting impact on revenue, cost, and profit.
⎯ These relationships can be expressed in terms of tables, graphs, or
algebraic equations.
Formula:
π (profit) = R − C
Average cost - calculated by dividing the total cost by the quantity.
✓ The relationship between average cost and quantity is the average
cost function.
B. Break-even Analysis
The volume level that separates the range with economic loss from
the range with economic profit is called the break-even point.
An equivalent approach is to find the value of Q where the revenue
function and cost function have identical values.
Another way to assess the break-even point is to find how large the
volume must be before the average cost drops to the price level.
❖ Contribution margin is the difference between total sales revenue and
total variable costs. It represents the portion of sales revenue that
contributes to covering fixed costs and generating profit.
❖ Contribution Margin = Sales Revenue - Variable
C. The Impact of Price Changes
1. Demand curve - Graphical representation of price and quantity
demanded
AE 11 MANAGERIAL ECONOMICS
2. Law of demand - Increase in price leads to decrease in quantity
demanded, and vice versa
3. Pricing strategy - Analysis of demand curve aids in determining
optimal price
D. Marginal Analysis
1. Marginal Revenue
✓ Measures change in revenue due to a unit increase in production level
✓ Provides insight into responsiveness of revenue function to changes in
quantity
✓ Helps determine if increasing or decreasing production volume is
beneficial.
2. Marginal Cost
✓ Measures change in cost corresponding to a unit increase in
production level
✓ Indicates how costs vary with changes in production quantity
3. Marginal Profit
✓ Measures change in profit resulting from a unit increase in quantity
✓ Helps assess the impact of changes in production volume on
profitability
4. Marginal Measures for Economic Functions
✓ rate of change in the function value corresponding to a modest
change in Q
✓ Related to the operating volume
✓ May vary depending on the assessed operating volume level
A. Optimum production level
✓ Identified where marginal profit equals zero
✓ Represents the most profitable production level
✓ Principle: Marginal revenue equals marginal cost at optimum level
B. Implicit Cost
1. Opportunity costs that arise from using resources in a particular way
rather than in an alternative way.
2. These costs are not incurred directly in monetary terms but represent
the benefits forgone by choosing one option over another.
Explicit Cost
1. Costs that involve direct monetary payment.
2. These costs are easily quantifiable and are recorded in financial
statements.