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Types of Cost and Profit Maximization

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Sabina M

on 19 December 2016

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Transcript of Types of Cost and Profit Maximization

Types of cost
Profit maximization

What is total cost?
What is profit

What is marginal cost?
Profit Maximization
Limitations of Profit Maximisation
What is cost?

An amount that has to
be paid or given up in
order to get something.

Sabina Mamedova
What is fixed cost?
What is variable cost?

A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produ-ced. Fixed costs are expenses that have to be paid by a company, independent
of any business activity.

In business, cost is usually a monetary valuation of effort, material, resources, time and utilities consu-med, risks incurred, and opportunity forgone in pro-duction and delivery of a good or service.

All expenses are costs, but not all costs are expenses.

Variable costs can include direct material costs or direct labor costs necessary to com-plete a certain project.

Average cost is the production cost per unit of output. Lower average costs are a potent competitive advantage.
Also called
unit cost

Average variable cost is a variable cost per unit of output.

What is marginal
Marginal cost
The marginal cost of production is the change in total cost that comes from making or producing one additional item.
Fixed cost
Variable cost
variable costs

total output
Total cost is all the costs incurred
in producing something or engaging in an activity.
Total cost
(FC + VC)

total output
total output
A process that companies undergo to determine the best output and price levels in order to maximize its return. The com-pany will usually adjust influential factors such as production costs, sale prices, and output levels as a way of reaching its
profit goal.
^total output
Marginal revenue (MR) is the increase in revenue that results from the sale of one additional unit of output.

Marginal Revenue
^total output
fixed cost
variable cost
total cost
Types of cost
In the real world it is not so easy to know exactly your marginal revenue and marginal cost of last goods sold.

For example, it is difficult for firms to know the price elasticity of demand for their good – which determines the MR.
It also depends on how other firms react. If they increase price, and other firms follow, demand may be inelastic.

But, if they are the only firm to increase price, demand will be elastic.
However, firms can make a best estimation. Many firms may have to seek profit maximisation through trial and error. e.g. if they see increasing price leads to a smaller % fall in demand they will try increase price as much as they can before demand becomes elastic.
It is difficult to isolate the effect of changing price on demand. Demand may change due to many other fac-tors apart from price.
Firms may also have other objectives and considera-tions.

For example, increasing price to maximise profits in the short run could encourage more firms to enter the market; therefore firms may decide to make less than maximum profits and pursue a higher market share.
That's All!...
Thanks for attention!
Methods of
Profit Maximizations
Profit maximisation occurs at the biggest gap between total revenue and total costs.
A firm can maximise profits if it produces at an output where Marginal revenue equals to Marginal cost.
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