7.0     INTRODUCTION

In business, cost refers to the total expenditure incurred to produce a good or provide a service.

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TYPES OF COST

• FIXED COSTS: Costs that remain constant regardless of the level of output produced.

CHARACTERISTICS OF FIXED COSTS

• Do not vary with production levels. Examples include rent, salaries of permanent staff, and depreciation of equipment.
• Fixed costs must be paid even if production is zero, affecting the overall profitability of a firm.
• VARIABLE COST: costs that change directly with the level of output.

CHARACTERISTICS OF VARIABLE COST

• Increase as production increases and decrease as production decreases. Examples include raw materials, direct labor costs, and utility costs that vary with usage.
• Variable costs are crucial for determining the total cost of production and can influence pricing strategies.
• TOTAL COST (TC): The overall cost incurred in the production of goods or services.
• Formula: Fixed Costs + Variable Costs.
• AVERAGE COST: The cost per unit of output produced. Formula: = Total Cost /Q ​where Q is the quantity of output.

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CHARACTERISTICS OF AVERAGE COST

• Average cost is important for pricing decisions and assessing economies of scale.
• MARGINAL COST: The additional cost incurred by producing one more unit of output.
• Formula: Marginal Cost = ΔTC / ΔQ

CHARACTERISTICS OF MARGINAL COST
Marginal cost is critical for decision-making regarding production levels; firms will continue to produce as long as the price exceeds marginal cost.

          7.1     THE CONCEPTS OF REVENUE

Revenue is the total income generated by a company from its business activities, typically through the sale of goods or services.

TYPES OF REVENUE

• TOTAL REVENUE: The total income generated from the sale of goods or services.
• Formula: Total Revenue = Price × Quantity Sold.
• Total revenue is a key indicator of a firm’s financial performance.

• AVERAGE REVENUE: The revenue earned per unit sold.
• Formula: AR = Total Revenue/Q
• Average revenue helps firms understand pricing strategies and market demand.

• MARGINAL REVENUE: The additional revenue gained from selling one more unit of a good or service.
• Formula = ΔTotal Revenue / ΔQ
• Marginal revenue is essential for determining the optimal level of production and pricing.

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          7.2     ACCOUNTANTS’ AND ECONOMISTS’ NOTIONS OF COST

• ACCOUNTANTS’ NOTION OF COST: Focuses on explicit costs, which are direct, out-of-pocket expenses. Includes fixed and variable costs but excludes opportunity costs. Provides a clear picture of cash flow and profitability.
• ECONOMISTS’ NOTION OF COST: Includes both explicit and implicit costs (opportunity costs).

7.3     SHORT-RUN AND LONG-RUN COSTS

• SHORT-RUN COSTS: A period in which at least one factor of production is fixed.

CHARACTERISTICS OF SHORT RUN COSTS

• Firms can only adjust variable factors (e.g., labor) to change output.
• Short-run cost curves include fixed costs, variable costs, and total costs.
• Short-run decisions are often constrained by fixed costs and existing capacity.
• LONG RUN COSTS: A period in which all factors of production are variable.

CHARACTERISTICS OF LONG RUN COSTS

• Firms can adjust all inputs to achieve the most efficient production level.
• Long-run average cost curve (LRAC) shows the lowest possible cost of production at each output level.
• Long-run decisions allow firms to optimize production and scale operations.

7.4     THE MARGINAL COST AND THE SUPPLY CURVE OF A FIRM

The marginal cost curve typically represents the supply curve for a firm in a competitive market.

• If the price is above the marginal cost, the firm will continue to produce.
• The upward slope of the marginal cost curve reflects increasing costs as production expands, indicating that firms will supply more at higher prices.