BUSINESS ECONOMICS

UNIT-I- INTRODUCTION
Meaning and Definitions of Business Economics
Nature and scope of Business Economics
Micro and Macro Economics and their differences.

UNIT-II- DEMAND ANALYSIS

Meaning and Definition of Demand
Determinants of Demand
Demand function
Law of demand
Demand Curve
Exceptions to Law of Demand.
UNIT III- ELASTICITY OF DEMAND
Meaning and Definition of Elasticity of Demand
Types of Elasticity of Demand
Measurements of Price elasticity of demand
Total outlay Method Point Method Arc Method.
UNIT IV- COST AND REVENUE ANALYSIS
Classification of Costs
Total - Average Marginal and Cost function
Long-run Short-run
Total Revenue - Average revenue Marginal Revenue.
UNIT-V- B REAK-EVEN ANALYSIS
Type of Costs
Fixed Cost
Semi-variable Cost
Variable Cost
Cost behaviour
Breakeven Analysis - Its Uses and limitations.

UNIT-I- INTRODUCTION
Introduction to Business Economics
Business Economics plays an important role in our daily economic life and business
practises. Economic theories, economic principles, economic laws, economic
equations, and economic concepts are used for decision making. Business Economics
is also known as "Managerial Economics". It is also known as " Applied

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Economics". Business Management means any activity undertaken to earn
profit, run by a person and managed with the help of economics. Therefore
Managerial Economics is also called Business Economics. In Managerial Economics
the concepts, principles and theories in pure economic science are applied to any
business activities. Therefore it is also called as Applied Economics.

Definitions of Business Economics or Managerial Economics

According to E. F. Brigham and J. L. Pappas, "Managerial Economics is the

application of Economic theory and methodology to business administration
practise."

According to M. H. Spencer and L. Siegelman, "Managerial Economics is the

integration of economic theory with business practise for the purpose of facilitating
decision making and forward planning."

According to Joel Dean, "The purpose of Managerial Economics is to show how

economic analysis can be used in formulating business policies."

Meaning of Business Economics or Managerial Economics

Business Economics or Managerial Economics generally refers to the integration of
economics theories with business practises. Economics provides various conceptual
tools like - Demand, Supply, Price, Competition, etc. Business economics applies
these tools to the management of business. In this sense, business economics also
known as applied economics.

Business Economics is the application of principles and theories of economics in

practise to run successfully the business. Everyday business manager has to face
different problems, while running the business. They would be solved with the help
of economic theories. Managers integrates the economic theories with the business
practises and takes decisions as well as plans the activities of business.

Characteristics of Business Economics

1. Micro Economic Nature

2. Use of Economic Theories

3. Realistic One

4. Normative Science

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5. Macro-Economic Uses

6. Economics is a science or an art

1. Micro Economic Nature

Business Economics is micro economic in its nature because it deals with matters of
a particular business firm only.

2. Use of Economic Theories

Business Economics uses all economic theories relating to the profits, distribution of
income etc.

3. Realistic One
Business Economics is a realistic science. It studies all matters concerning business
organization by considering the real conditions existing in the business field.

4. Normative Science
Business Economics is a normative science. It studies the matters concerning the
aims and objectives of a business firm. It determines the methods to be adopted for
achieving such objectives. It also makes enquiry into the good and bad in decision
making. Hence it is a normative science.

5. Macro-Economic Uses
Even though Business Economics has the nature of Micro-Economics, it also uses
Macro-Economic approaches frequently. Certain matters in Macro-Economics like
Business Cycles, National Income, Public Finance, Foreign trade etc. are essential for
Business Economics.

6. Economics is a science or an art

It is considered as science if it is a systemized body of knowledge which
studies the relationship between cause and effect.
Art is nothing but practice of knowledge.
Whereas science teaches us to know and art teaches us to do.
It is science in which methodology and art in its application.

Scope of Managerial Economics

The scope of managerial economics is not yet clearly laid out because it is a
developing science. Even then the following fields may be said to generally fall under
Managerial Economics:
1. Demand Analysis and Forecasting

2. Cost and Production Analysis

3. Pricing Decisions, Policies and Practices

4. Profit Management Page 30

5. Capital Management
These divisions of business economics constitute its subject matter.

Recently, managerial economists have started making increased use of Operation

Research methods like Linear programming, inventory models, Games theory,
queuing up theory etc., have also come to be regarded as part of Managerial
Economics.

1.Demand Analysis and Forecasting

A business firm is an economic organization which is engaged in transforming
productive resources into goods that are to be sold in the market. A major part of
managerial decision making depends on accurate estimates of demand. A forecast of
future sales serves as a guide to management for preparing production schedules and
employing resources. It will help management to maintain or strengthen its market
position and profit base.

Demand analysis also identifies a number of other factors influencing the demand for
a product. Demand analysis and forecasting occupies a strategic place in Managerial
Economics.

2.Cost and production analysis

A firms profitability depends much on its cost of production. A wise manager would
prepare cost estimates of a range of output, identify the factors causing are cause
variations in cost estimates and choose the cost-minimizing output level, taking also
into consideration the degree of uncertainty in production and cost calculations.
Production processes are under the charge of engineers but the business manager is
supposed to carry out the production function analysis in order to avoid wastages of
materials and time. Sound pricing practices depend much on cost control. The main
topics discussed under cost and production analysis are:

Cost concepts
cost-output relationships
Economics and Diseconomies of scale and cost control.

3.Pricing decisions, policies and practices

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Pricing is a very important area of Managerial Economics. In fact, price is the genesis
of the revenue of a firm ad as such the success of a business firm largely depends on
the correctness of the price decisions taken by it.

The important aspects dealt with this area are: Price determination in various market
forms, pricing methods, differential pricing, product-line pricing and price
forecasting.

4.Profit management
Business firms are generally organized for earning profit and in the long period, it is
profit which provides the chief measure of success of a firm. Economics tells us that
profits are the reward for uncertainty bearing and risk taking. A successful business
manager is one who can form more or less correct estimates of costs and revenues
likely to accrue to the firm at different levels of output.

The more successful a manager is in reducing uncertainty, the higher are the profits
earned by him. In fact, profit-planning and profit measurement constitute the most
challenging area of Managerial Economics.

5.Capital management
The problems relating to firms capital investments are perhaps the most complex
and troublesome. Capital management implies planning and control of capital
expenditure because it involves a large sum and moreover the problems in disposing
the capital assets off are so complex that they require considerable time and labour.
The main topics dealt with under capital management are cost of capital, rate of
return and selection of projects.

Definition of Micro Economics

Microeconomics is the branch of economics that concentrates on the behaviour and
performance of the individual units, i.e. consumers, family, industry, firms. Here, the
demand plays a key role in determining the quantity and the price of a product along
with the price and quantity of related goods (complementary goods) and substitute
products, so as to make a judicious decision regarding the allocation of scarce
resources, concerning their alternative uses.

Examples: Individual Demand, Price of a product, etc.

Definition of Macro Economics

Macroeconomics is the branch of economics that concentrates on the behaviour and
performance of aggregate variables and those issues which affect the whole economy.
It includes regional, national and international economies and covers the major areas

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of the economy like unemployment, poverty, general price level, GDP (Gross
Domestic Product), imports and exports, economic growth, globalisation, monetary/
fiscal policy, etc. It helps in resolving the various problems of the economy, thereby
enabling it to function efficiently.

Micro and Macro Economics - Differences

UNIT-II- D EMAND ANALYSIS

Meaning and Definition of Demand

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 Demand in economics means a desire to possess a good supported by willingness
and ability to pay for it.
If you have a desire to buy a certain commodity, say a car, but you do not have the
adequate means to pay for it, it will simply be a wish, a desire or a want and not
demand.
Demand is an effective desire, i.e., a desire which is backed by willingness and
ability to pay for a commodity in order to obtain Prof. Hibdon:

Determinants of Demand
When price changes, quantity demanded will change. That is a movement along the
same demand curve. When factors other than price changes, demand curve will shift.
These are the determinants of the demand curve.

There are various factors affecting the demand for a commodity.They are:

1.Price of the good

2.Price of related goods

3.Consumers Income

4.Taste, preference, fashions and

habits

5.Population

6.Money Circulation

7.Value of money

8.Weather Condition

9.Advertisement and Salesmanship

10.Consumers future price expectation

11.Government policy (taxation)

12.Credit facilities

13.Multiplicity of uses of goods

1.Price of the good: The price of a commodity is an important determinant of

demand. Price and demand are inversely related. Higher the price less is the demand
and vice versa.

2.Price of related goods: The price of related goods like substitutes and
complementary goods also affect the demand. In the case of substitutes, rise in price

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of one commodity lead to increase in demand for its substitute. In the case of
complementary goods, fall in the price of one commodity lead to rise in demand for
both the goods.

3.Consumers Income: This is directly related to demand. A change in the income

of the consumer significantly influences his demand for most commodities. If the
disposable income increases, demand will be more.

4.Taste, preference, fashions and habits: These are very effective factors affecting
demand for a commodity. When there is a change in taste, habits or preferences of
the consumer, his demand will change. Fashions and customs in society determine
many of our demands.

5.Population: If the size of the population is more, demand for goods will be more .
The market demand for a commodity substantially changes when there is change in
the total population.

6.Money Circulation: More the money in circulation, higher the demand and vice
versa.

7.Value of money: The value of money determines the demand for a commodity in
the market. When there is a rise or fall in the value of money there may be changes in
the relative prices of different goods and their demand.

8.Weather Condition: Weather is also an important factor that determines the

demand for certain goods.

9.Advertisement and Salesmanship: If the advertisement is very attractive for a

commodity, demand will be more. Similarly if the salesmanship and publicity is
effective then the demand for the commodity will be more.

10.Consumers future price expectation: If the consumers expect that there will be
a rise in prices in future, he may buy more at the present price and so his demand
increases.

11.Government policy (taxation): High taxes will increase the price and reduce
demand, while low taxes will reduce the price and extend the demand.

12.Credit facilities: Depending on the availability of credit facilities the demand for
commodities will change. More the facilities higher the demand.

13.Multiplicity of uses of goods: if the commodity has multiple uses then the
demand will be more than if the commodity is used for a single purpose.

Demand -Function

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Demand Function shows the relationship between demand for a commodity and
factors affecting it. It states the functional relationship between the demand for a
commodity and it's determining factors. These factors are as follows price of a
commodity income, prices of substitules and complementary goods, tastes and
preferences of people, fashions, population etc. Therefore the functional relationship
between these determinant factors and demand for a commodity is called as demand
function. It is mathematically shown as follow.

D = F (a, b, c, d, e.......n)

where,

D = Demand for commodity

F = Function

a = price of commodity

b = Income of people

c = price of substitules and complementaries

d = population

e = Tastes and preferences of people

n = nth or last factor affecing the demand.

Law of Demand
'Alfred marshall' stated the law of demand as "other things being constant, if price of
a commodity increases it's demand decreases and if price decreases it's demand
increases."

This law shows the inverse relationship between the two variables demand and price
of a commodity. Other things means the income, prices of substitutes and
complementaries, tastes and preferences of people, population etc. When all of these
other factors remain constant, the Law of demand founds to be true.

Assumptions

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The Law of demand is based on following assumptions.

1. Consumer's tastes and preferences remain constant. i. e. There is no change in

it.
2. Income remains constant.
3. Prices of substitues and complementaries remain constant.
4. No substitute is available to the commodity.
5. Population remains constant.

Demand Schedule
Demand Schedule of a individual consumer reveals that when price falls as Rs. 5 to 4,
3, 2, 1 the quantity demanded will increase as 10, 20, 30, 40 to 50 units respectively.
It shows the inverse relationship between price and demand of a commodity. With
the help of demand schedule, we can draw the demand curve as follows.

Demand (In
Price (in Rs.)
Units)
5 10

4 20

3 30

2 40

1 50

By taking the quantity demanded on x-axis and price on Y-axis. DD demand curve is
drawn. If falls from left to right and shows the inverse relationship between price and
demand of a commodity. Thus demand curve is downward slopping curve. Or falls
from left to right downwards.

Limitations
All above assumptions are the limitations to the Law of demand. They are as follow.

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 1. Change in Income

2. Change in Tastes and

Preferences

3. Change in prices of other

goods

4. Population change

5. Availability of close substitutes

1. Change in Income
If there is change is consumer's income. Law of demand does't operate.

2. Change in Tastes and Preferences

If the tastes and preferences of people may go on change, the law of demand could
not be found true.

3. Change in prices of other goods

If prices of other goods i. e. substitutes and complementaries are changed, the law of
demand doesn't show the inverse relationship between price and demand for a
commodity.

4. Population change
If Population changes the law of demand does not found true.

5. Availability of close substitutes

If there is existence of close substitutes to consumer's goods, the law of demand
doesn't fulfil the inverse relationship between price and demand.

Exceptions
There are few exceptions to the law of demand. In some particular situations it will
not be existed.

1. War

2. Economic Depression

3. Status symbol commodities

4. Giffen goods

5. Essential goods

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1. War
War period is exception to the law of demand. In this period scarcity of various goods
is prevailing in the country. So people are purchasing goods more at higher prices
also. It means that during the war period even though commodity prices remain
high, people can demand more and more goods.

2. Economic Depression
The period of economic depression is also another exception to the law of demand.
During this period commodity prices are existing at it's lowest level, till people do not
demanding it in a large quantity. It means that during the period of economic
depression price and demand both are remaining lower. Hence law of demand
doesn't be operated.

3. Status symbol commodities

Precious commodities like diamonds, precious stones, old and scare pictures, idols
etc. are the status symbols and it is always purchased by the rich people to confer
social distinction. These commodities are not purchased for their intrinsic value but
for the prestige they confer upon the possessor. Therefore as the price of these goods
falls, demand also falls and vice versa.

4. Giffen goods
Giffen goods are the low priced or inferior goods. They are exception to the law of
demand. A fall in its price tends to reduce its demand and rise in price causes to
increase the demand. This relationship was searched by Sir Robert Giffen. Hence, it
is named as Giffen goods.

5. Essential goods
The goods which are necessary to life of human beings. A consumer doesn't reduce
its daily consumption as its price rises or doesn't increase or price falls. e. g. A family
required 10 kg of rice per month, as price of rice rises family chief doesn't reduce its
consumption below 10 kg. If he does so, starvation would occur in his family.

On the other hand price of rice falls, he can't consume 50 kg. of rice per month
instead of 10 kg. Thus, the nature of life necessary goods is such that it's
consumption cannot be changed as price changes.

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 UNIT III- ELASTICITY OF DEMAND
Elasticity of demand refers to the rate of change of demand to the rate of change in
price. Law of demand only expresses the inverse relationship between price and
demand of a commodity. But it doesn't say about the proportionate change in
demand to the proportionate change in price. Therefore the concept of elasticity of
demand is developed, by 'Alfred Marshall'.

Elasticity of demand is defined as "It is ratio of proportionate change in quantity

demanded to the proportionate change in price of a commodity." It means that
elasticity of demand shows the ratio of percentage change in demand to the
precentage change in price. Thus, the elasticity of demand expresses the degree of
correlation between demand and price. It is the rate at which quantity demanded
varies with a change in price.

With the help of this definition elasticity of demand is expressed in mathematical

term as :

e. g. Let us assume that price of a commodity is decreased, from Rs. 10 to Rs. 5 so

that demand increased from 10 to 20 units. Therefore elasticity of demand is
calculated as :

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Elastic and inelastic Demand
When the small change in price causes large change in demand, it is called as elastic
demand e. g. Suppose rise in price by 2%, causes fall in demand by 10% it result into
elastic demand.

In regards to this elasticity of demand is calculated as e = q / p = 10/2 = 5. When the

elasticity of demand is greater than, 1, (e 1). This type of change in demand is called
elastic demand.

Inelastic demand
When a big change in price causes a small change in demand, it is referred as
inelastic demand. e. g. If price falls by 5% and demand rises by 4%. It results into
inelastic demand. e = q / p = 4/5 = 0.80%. The elasticity of demand is less than 1.

(e 1).

Types of Elasticity of Demand

There are three types of elasticity of demand.

1) Price elasticity of demand

2) Income elasticity of

demand

3) Cross elasticity of demand

1) Price elasticity of demand
The concept of price elasticity of demand is concerned with the change in price to the
change in demand. It shows the effect of change in price to the change in demand.
"Marshall" was the first economist, who defined the price elasticity of demand as the
ratio of percentage change in quantity demanded in response to a percentage change
in price. Mathematically it is shown as : demand increased form 10 to 20 units.
Therefore elasticity of demand is calculated as :

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There are five cases of elasticity of demand

1) Perfectly elastic or infinite elasticity

demand

2) Perfectly Elastic demand

3) Relatively Elastic demand

4) Relatively Inelastic demand

5) Unit Elastic demand.

1) Perfectly Elastic or infinite elastic demand

When a small change in price leads to very large amount of change in demand, it is
called as perfectly or infinitely elastic demand. Is is diagrammatically represented as
follow.

DD is horizontal straight line demand curve. It

shows that small fall in price leads to an unlimited
increase in demand. It is hyper sensitive demands
and elasticity of demand is infinite.

2) Perfectly Inelastic demand

When any change in price doesn't cause any change in price, it may be large or small
doesn't cause any amount of change in demand. In this case demand remains

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constant to change in price. So it is called perfectly inelastic demand. It is
diagrammatically shown as below.

DD is demand curve. It is vertical straight line

curve parallel to Y axis. It shows there is no
change in quantity demanded as price changes.
Price changes from OP to OP1 , but demand
remains OD i. e. same.

3) Relatively Elastic Demand (e 1)

When change in price is followed by big change in demand, it is called elastic

demand. In other words, when the change in quantity demanded is greater that
change in price is called relatively elastic demand. In this case elasticity of demand is
greater, than 1. (e 1). It is diagrammatically shown as follow

In the figure, change in price PP1 is smaller than the

change in demand QQ1. Therefore, DD demand curve
is flatter.

4) Relatively Inelastic demand (e 1)

When change in demand is smaller than change in price, it is referred as relatively

inelastic demand i. e. Large change in price leads to smaller change in quantity
demanded. Diagrammatically it is shown as follow.

DD is downward slopping demand curve. It shows that

change in price PP1 is greater than change in quantity
demanded QQ1. Hence, the demand is inelastic.

5) Unit Elasticity of demand (e = 1)

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When the change in price is exactly equal to the change in demand, it is referred as
unitary elastic demand. Here, demand changes in equal proportion of change in
price. Therefore elasticity of demand is equal to 1. It is diagramatically shown as
below.

DD is downward slopping demand curve. It shows

that change in price PP1 is greater equal to the change
in quantity demanded QQ1. Therefore price elasticity
of demand is equal to 1, or it is called the unitary
elastic demand.

Measurements of Price elasticity of demand

i. Total outlay
Method
ii. Point Method
iii. Arc Method.

I ) Total Outlay Method or Total Expenditure Method

In this method change in total expenditure on a commodity resulted due to the price
change is compared and elasticity is measured. These changes are compared in three
ways as below.

i. When change in price (rise or fall). doesn't lead to change in the total outlay
on a commodity, it maens that if price changes but total outlay on a
commodity doesn't change or remains the same. It is referred as unitary
elastic demand. or e = 1.
ii. In this case, price rise is followed by decrease in total outlay or fall in price is
resulted into rise in total outlay on a commodity. It is called as elastic demand
In this case elasticity of demand is greater than 1. (e 1).
iii. If price rises, total outlay also rises or price falls, total outlay also falls. This
type of elasticity is called as inelastic demand. Also it is referred as price
elasticity of demand is less than one (e 1).

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II) Point Method
In this method the elasticity of demand is measured at any point on demand curve.
When the demand curve is a straight line demand curve. In order to measure
elasticity of demand at any point on a demand curve, the formula used is as below.
Elasticity of demand at any point on demand curve is the ratio of lower part of the
demand curve to the upper part of the demand curve, from that point, where
elasticity of demand is to be measured.

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III) Arc Elasticity of Demand
Arc elasticity is a measure of the average responsiveness to price change exhibited
by a demand curve over some finite stretch of the curve Prof. Baumol

When elasticity is computed between two separate points on a demand curve, the
concept is called Arc elasticity Leftwitch

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2. Income Elasticity of demand
When person's income affects the demand for a commodity it results in to income
elasticity of demand. As income changes, demand also changes. "The Ratio of change
in income to the change in demand is referred as the income elasticity of demand."

It measures the responsiveness of demand to changes, in income. Therefore it is

defined as "Income elasticity of demand is to ratio of the percentage change in the
quantity demanded to the percentage change in income."

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3. Cross - Elasticity of Demand
There are many substitutes or complementary goods available to any commodity in
market. Therefore, if there is change in the price of substitutes, it affects the demand
for a particular commodity. Therefore the concept of elasticity of demand is applied
to the two commodities related to each other. The relationship between the two
commodities can be either substitutive or complementary. In the context of these
relationship, the term cross elasticity of demand is used.

Cross elasticity of demand is defined as "The ratio of proportionate change in

quantity demanded of commodity A to a given proportionate change in the price of
related commodity B." In order to calculate the cross elasticity of demand following
formula is used. P

Suppose, that A and B are two commodities substitutes to each other. If the price of B
rises and the price of A remains constant, it causes to rise in the quantity demanded
of commodity A. Because the consumers will substitute A for B. On the contrary if
price of A rises and B's price remains constant. It leads to rise in demand of a
commodity B. Because now consumers are preferring B for A.

The cross elasticity of demand may be infinity or zero. Also it may be positive, or
negative. When goods are perfect substitutes to each other cross elasticity may be
infinity. Where two goods are not substitutes to each other cross elasticity of demand
will be zero. It means that change in price of one commodity doesn't affect the
demand for another commodity. The cross elasticity varies between two extermes
infinity and zero. It depends upon the degree of substitutability.

When the two goods are substitues to each other, then the cross elasticity of demand
is positive (+ve). When the two goods are complementary to each other, the cross
elascitity is negative (-ve)

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 UNIT IV- COST AND REVENUE ANALYSIS

Types of Costs

1. Fixed Costs (FC)

2. Variable Costs (VC)
3. Semi-Variable Cost
4. Marginal Costs
5. Opportunity Cost
6. Economic Cost
7. Accounting Costs
8. Sunk Costs
9. Avoidable Costs

1. Fixed Costs (FC): The costs which dont vary with changing output. Fixed costs
might include the cost of building a factory, insurance and legal bills. Even if your
output changes or you dont produce anything, your fixed costs stay the same. In the
above example, fixed costs are always Rs. 1,000.

2. Variable Costs (VC): Costs which depend on the output produced.

For example, if you produce more cars, you have to use more raw materials such as
metal. This is a variable cost.

3. Semi-Variable Cost: Labour might be a semi-variable cost. If you produce more

cars, you need to employ more workers; this is a variable cost. However, even if you
didnt produce any cars, you may still need some workers to look after empty factory.

Total Costs (TC) Fixed + Variable Costs

4. Marginal Costs: Marginal cost is the cost of producing an extra unit. If the total
cost of 3 units is Rs. 1550, and the total cost of 4 units is 1900. The marginal cost of
the 4th unit is Rs. 350.

5. Opportunity Cost: Opportunity cost is the next best alternative foregone. If you
invest Rs. 1 million in developing a cure for pancreatic cancer, the opportunity cost is
that you cant use that money to invest in developing a cure for skin cancer.

6. Economic Cost: Economic cost includes both the actual direct costs (accounting
costs) plus the opportunity cost.

For example, if you take time off work to a training scheme. You may lose a weeks
pay of Rs. 350, plus also have to pay the direct cost of Rs. 200. Thus the total
economic cost = Rs. 550.

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7. Accounting Costs: This is the monetary outlay for producing a certain good.
Accounting costs will include your variable and fixed costs you have to pay.

8. Sunk Costs: These are costs that have been incurred and cannot be recouped. If
you left the industry, you could not reclaim sunk costs.

For example, if you spend money on advertising to enter an industry, you can never
claim these costs back. If you buy a machine, you might be able to sell if you leave the
industry.

9. Avoidable Costs: Costs that can be avoided. If you stop producing cars, you dont
have to pay for extra raw materials and electricity. Sometimes known as an escapable
cost.

Total - Average and Marginal Cost function

Short run Cost curves

In the short run certain factors are fixed certain other variable. Accordingly, certain
costs are fixed and certain costs variable.

In the short run there are three costs - total fixed cost, total variable cost and total
cost. In addition there are four per unit costs- average fixed cost, average variable
cost, average cost and the marginal cost.

Illustration: for a given TFC of 100 and TVC over 8 units, the costs will be

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1. Total Fixed cost
The fixed cost remains constant in the short run at level of output. The fixed cost
curve is a horizontal curve parallel to x axis. At zero level of out put the total cost is
equal to total fixed cost.

2. Total variable cost

The total variable cost increases with increasing cost. The shape of the variable cost
curve is drawn from the law of variable proportions. This it has three segments. At
zero level of output the variable cost is zero.

3. Total cost

Total cost = Total fixed cost + Total variable cost

The total cost is the sum of total fixed cost

and total variable cost. At zero level of out put
the total cost is equal to total fixed cost. The
shape and size of total cost is similar to total
variable; cost but it starts form total fixed
cost.

4. Average Fixed cost

Average Fixed Cost = Total fixed cost/ Out put

Average fixed cost curve is a downward sloping curve. It keeps on decreasing, but
never touches the axis. It is asymptotic to x axis. Geometrically, on this curve the
product of coordinates always a constant.

5. Average Variable Cost

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 Average Variable Cost = Total Variable Cost/ Output

Average variable cost is a broad U shaped curve; the shape of the curve is drawn from
the behavior of variable facto and the law of variable proportions.

6. Average Cost
Average Cost = Total cost/ Out put
Or

Average Cost = Average Fixed cost + Average Variable

Average cost curve is a U shaped curve; the shape is derived by the combination AC
and AVC. AC curve lies above AVC. Average cost is minimum when AC = MC

7. Marginal cost

Marginal cost = TC (n-1) - TC n

Marginal cost curve is a J shaped curve. It passes through the minimum point of AC.
When AC=MC, Marginal cost is minimum. The shape is derived from the behavior
of marginal product in the law of variable proportions.

The short run Average Cost Curve is a U shaped Curve

The U shape of the average cost curve is made up of three segments; down ward part,
change in the trend and upward trend:

i. Initially, AVC and AFC are both decreasing so the resultant AC also decreases
ii. There after, AFC continues to decrease but AVC increases. There is a change it the
trend. The decreasing curve now changes trend towards increase.
iii. Finally, the increasing AVC is stronger than decreasing AFC and AC now
continues to increase.

The AC curve takes a U shape.

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Further, Average Cost = Average Fixed cost + Average Variable Cost

So, the gap between AVC and AC is equal to AFC.

Long run costs

The long run cost curves are derived from the

short run cost curves. The long run AC is
derived from the short run AC. In the long
run when the scale of production increases,
the AC curves shift down wards showing
decreasing costs. This is due to economies of
scale. This is case of DECREASING COSTS.

In the long run, when the scale of production

increases, the AC curves may shift horizontally to
the right. This is due to neutral economies of
scale. This is case of CONSTANT COSTS.

In the long run when the scale of production

increases, the AC curves shift upwards showing
increasing costs. This is due to diseconomies of
scale. This is case of INCREASING COSTS

The long run AC is made up of these three segments. Thus the LAC is flatter than the
SACs. The LAC is also called the envelope curve. For this reason The long run
average cost curve is flatter than the short run average cost curve. Long run
Marginal cost curve passes through the minimum point of LAC.

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Meaning of revenue
The amount of money which the firm receives by the sale of its output in the market
is known as its revenue. It is also known as Sales Receipts. There are three types
of Revenue.

Total revenue
Total revenue refers to the total amount of money that a firm receives from the sale
of its products.

Mathematically,

TR = P x Q

Where,

TR=Total Revenue
P=Price
Q=Quantity sold
Example: If the shopkeeper sold 10 boxes of chocolates each at Rs. 500/- then his
total revenue would be

TR = P x Q

= 500 x 10

TR= 5,000

Average revenue
Average revenue is the revenue per unit of the commodity sold. It is calculated by
dividing the total revenue by the number of units sold.

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 TR
AR =
Q
Where,

AR=Average Revenue
TR=Total Revenue
Q=Quantity
Or

P Q
AR =
Q
Where

AR=Average Revenue
P=Price
Q=Quantity sold
Or, AR=P

Thus, average revenue means price of the product.

Example

If the seller made revenue of 25000 selling 10 sarees, then the average revenue per
saree is

AR= TR / Q

=25000/10

AR= 2,500/-

Marginal Revenue
Marginal revenue is the addition made to the total revenue by selling one more unit
of a commodity

ChangeTR
MR=
ChangeQ

Or,

MRn = TRn-1 TRn

Where,

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 Q= number of units

MR = Marginal revenue of the nth unit

TRn = Total revenue of n units

TR n-1 = Total revenue of n-1 units

Example

If the total revenue of a merchant by selling 50 mobile phones is 5,00,000 and by

selling 51 mobiles phones, it is 5,20,000, then MR is

MR51 = TR at 51 TR at 50

= 5,20,000 5,00,000

MR = 20,000.

UNIT-V- BREAK-EVEN ANALYSIS

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Break even Analysis
Break even out refers to the level of output where TR = TC. This is the minimum out
put the firm need to produce its costs. Any output thereafter will grant profit to the
firm. Usage of breakeven point for corporate decision making is called Break even
analysis. At breakeven point total cost is equal to total revenue. After breakeven point
the profitability begins. The output less than break even output shows losses.

Every firm aims at breakeven level of output in the beginning. The breakeven level is
a no profit no loss condition. In other words it is case of normal profits. The costs
cover only the managers remuneration and there is no surplus over that. It is similar
to the condition AR = AC

Assumptions of Break even analysis

Break even analysis is based on the following Assumptions

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1. The cost and revenue functions are linear functions. This is for the sake of
simplicity.
2. The firm can estimate the cost and revenues in advance.
3. Price remains uniform at all levels of output.
4. The costs are made up of fixed and variable costs.

Uses/Applications of Break even analysis

A firm will firstly, attain the break even output so that it can be out of losses and
start making profits.
However, the firm needs to allot revenues for different purposes depending on
the earnings of profit or revenue.
Firstly, the firm will slot revenue for depreciation on assets. Depreciation is a
nominal expenditure. It is that part of fixed assets that is consumed during the
year and that part of fixed cost that can be charged to the output. Depreciation is
the first priority after attaining break even output.
When a firm makes profits it has to pay taxes. The firm now provides for taxes
after deducting depreciation.
Thereafter, marketing overheads can be deducted. These marketing overheads
are for more than one year. So if the revenue permits the firm may provide for
durable marketing overheads.
Finally, the revenue in excess of all these provisions yield profits that can be
distributed among owners or retained as reserves and surplus.

Limitations of Break Even Analysis

1. Break-even analysis is only a supply side analysis, as it tells you nothing about
what sales are actually likely to be for the product at these various prices.
2. It assumes that the price remains uniform at levels of output.
3. It assumes that fixed costs are constant.
4. It assumes average variable costs are constant per unit of output,
5. It assumes that the quantity of goods produced is equal to the quantity of goods
sold.
6. In multi-product companies, it assumes that the relative proportions of each
product sold and produced are constant.
7.

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