FIRMS

• Cost, Revenue & Objectives

• Market Structure: Competition & Monopoly
• Business Structure or Types of Business Organisation
Costs of production
• Cost of production is the sum of expenses that firms face while
procuring factors of production to produce goods and services.
• Firms usually assess costs in two time periods and these are:
1. Short run: a time period in which firms can change its variable
factors to increase or reduce the level of output produced while at
least one factor of production remains fixed. In other words, in
the short run firms operate with a fixed factor and can only
change variable factors.
2. Long run: a time period in which firms can change all factors of
production, including the fixed factor, to either increase or reduce
output. (*recall economies/diseconomies of scale). In the long run
firms can change its scale of production.
Short run costs
• Fixed cost: also known as indirect costs or overheads are the
expenses a firm incurs in procuring the fixed factors i.e. factors
of production which can not be changed in the short run. These
costs do not change with changes in the level of output
produced by a firm and remains constant over a relevant range
of output (i.e. over a scale of production). Examples: rent,
insurance, subscription fees, interest on loans etc.
• Variable cost: also known as direct or prime costs are expenses
a firm incurs in procuring variable factors of production i.e.
factors of production which change directly with changes in
output levels. Examples: cost of raw materials, electricity bills
etc.
Fixed cost diagram
Cost ($)

100 Total Fixed Cost

Output
10 20 30
Variable cost diagram
Cost ($) Total Variable cost

120

80

40

Output
10 20 60
Total cost
• A firms total cost is the sum of its total fixed cost and
total variable cost for a given level of output.
• TC = TFC + TVC
• Since total variable cost is zero when output is zero,
total cost must then be equal to total fixed cost.
• TC = TFC + 0
• Therefore, at zero output, TC = TFC
Total cost Diagram
TC TVC
Cost ($)

C
TF

100 TFC

Output
Average Cost
• Average cost (AC) or Average Total Cost (ATC) is the cost
per unit of output i.e. the cost of producing each unit of
output.
• AC = TC/Q alternatively AC = AFC + AVC
• Average variable cost is the variable cost of producing
each unit of output.
• AVC = TVC/Q
• Average fixed cost is the fixed cost per unit of output or
the fixed cost of producing each unit output.
• AFC = TFC/Q
Average Fixed Cost curve
Cost ($) Average fixed falls continuously with an increase in output

50

25

12.5
AFC
Output
2 4 8
Average Variable Cost curve
Cost ($)
AVC

50
47.5 The curve is U shaped
45 due to increasing and
diminishing returns

Output
10 15 40
Average Total Cost curve
Cost ($)
• AC = AFC + AVC
• AFC = AC - AVC AC
AVC

AFC

Output
Revenue
• A firms total revenue or total income is the sum of the
total receipts from the sales of output.
• Therefore, total revenue is the product of price and total
amount of output sold.
• TR = P × Q
• Average revenue is the revenue earned from the sales of
each unit of output.
• AR = TR ÷ Q
• Therefore, it follows that AR = P since P = TR ÷ Q
Total Revenue curve
TR
Revenue ($)

15

10

Output
20 30
Profit
• Profit is the positive difference between a firms total
revenue and its total cost.
Revenue($) TR
Breakeven point

ofit
Pr TC

ss at Q units, TR =
Lo TC

Output
Q
Objectives of firms
Profit Maximisation : A firm maiximising profits produces a level of output at
which the positive difference between a firm’s total revenue and the firm’s
total cost is maximum.
Revenue/Cost($)

TC

TR

Output
Q
Revenue/Sales revenue maximisation
• A firm maximising revenue produces a level of output at which the firms
total revenue is at its maximum. In other words, when the firms total
income (distinguish it from profits) is maximised.
Revenue/Cost($) Notice that
revenue
maximisation
TC takes place at
higher level of
output compared
to profit
TR maximisation.

Output
Q QR
Profit maximisation vs. Revenue maximisation
Profit maximisation
Higher retained profits to finance
future investments and expansion
Greater returns to share holders or
higher wages paid to workers
Investments in R&D can be increased
Retained profits can help firms to
withstand unexpected economic
events
Revenue maximisation
Increased sales as price is lowered
helping to gain market entry
Increase in market share helps to
exercise more power in the long run
Increased output can help firms reap
the benefits of economies of scale
Firms charge a lower price and this
can enable firms to compete out
rivals.
Other objectives
• Profit satisficing: producing a level of output that yields
enough profits to satisfy the shareholders or owners of the
business. This objective is often set by firms in which there is
a divorce between ownership and control. Due to this
separation owners and managers might have conflicting aims
or objectives. In such circumstances, managers often generate
profits that keeps owner’s happy instead of setting the
objective to profit maximisation.
• Social welfare: some firms move away from conventional
objectives and often engage in activities that benefits the
society as a whole. State owned firms have a tendency to
operate with such objectives. For example, a state owned firm
might focus more on creating sustainable employment
opportunities rather than setting conventional objectives.
Market Structures

Perfect competition vs. Monopoly
Perfect Competition
1. Large number of producers.
2. Large number of consumers.
3. Low or no entry/exit barriers.
4. All firms and consumers are price
takers i.e. they accept the price
decided by the market.
5. Products are perfect/close
substitutes of each other.
6. Existing firms can only make
normal profits in the long run.
7. Firm’s only objective is profit
maximisation.
Monopoly
1. Single producer or one producer
has more than 25% of the market
share while others a small firms.
2. Large number of consumers.
3. High entry/exit barriers.
4. Producers are price makers i.e.
they can control price or output.
5. Products do not have any close
substitutes.
6. A monopolist makes supernormal
or abnormal profits in the long
run.
7. Firm can have alternative
objectives such as revenue or
sales maximisation.
Evaluating competition
Advantages
• Consumer’s enjoy low product
price.
• Consumer’s enjoy a wider choice.
• Competition regulates the firms
and no form of government
interference is required.
• Firms use resources efficiently
preventing resource
misallocation or wastage.
• Firms do not compromise with
product quality as it can mean a
loss of market share.
Disadvantages
• Firms fail to enjoy economies of
scale and are high cost
producers charging higher price.
• Products are standardised across
all producers and hence no true
variety is enjoyed by consumers.
• Too much competition and the
inability enjoy economies of
scale can mean resource overuse
or wastage.
• Firms fail to invest in R&D and
product innovation rate falls
overtime.
Evaluating Monopoly
Advantages
• Monopoly enjoys economies of scale and
passes on the cost saving in the form of
low price.
• Monopoly enjoys supernormal profits and
invests it in R&D to innovate both
products and production process.
Consumers enjoy improved products over
time.
• Monopoly survives by preventing entry of
new firms. This might encourage them to
keep prices low while not compromising
product quality.
• Profits made by monopoly firms allow
these to survive when economic
conditions are unfavourable. Such firms
thus ensure stable supply of goods.
Disadvantages
• Single producer devoid of competition
might prioritise profits and to achieve
it, is likely to restrict output and
charge a high price.
• With competition absent and
consumers deprived of choice,
monopoly might exploit the situation
by providing low quality goods.
• Absence of competitive threats might
also discourage monopoly firms from
investing in R&D. This can lead to
inefficiency and wastage of resources.
Business Structures/Types of Business Organisation
• Sole proprietorship/sole trader: a business owned and controlled by one individual.
• Partnerships: a business setup through a legally binding agreement between a minimum of two
and a maximum of twenty individuals where each participating member owns, finances and
controls the business to enjoy profits and share losses usually in proportion to their invested
amount or in any other arrangement as agreed in the partnership agreement.
• Joint stock company or Limited company: is a business owned and controlled by shareholders or
an elected body of directors who are either shareholders or employed individuals.
➢ Private limited company has one or more shareholders but share issue is limited to family
members or friends & acquaintances.
➢ Public limited company has at least two shareholders and shares or ownership can be sold to
any individual or another organization through the stock exchange.
• Multinational corporations (MNC) or transnational corporations (TNC): Multinational firms are
firms with production and operational facilities in more than one country.
• Cooperatives: are business owned and controlled by individuals who undertake operations for
their mutual benefit.
• Public sector firms: are owned and operated by the state or the government and usually operate
with a welfare motive.
Sole trader
Advantages Disadvantages
• Gathering finance can be difficult
• Easy to setup.
and thus sole traders frequently
• Independence in decision making
fail to expand business.
and control provides greater
• Since management is entirely up
flexibility and ability to respond
to the owner it is unlikely that
to changes in demand pattern.
the individual will have expertise
• Sole claimant to profits.
in all aspects. This limits the
• Good interpersonal relationships
businesses prospects.
with clients or customers help to
• Attracting expert workers can
develop loyalty.
prove to be difficult.
• A sole trader also suffers from
unlimited liability.
Partnership
Advantages
• Gathering capital for
investment is easier in
partnerships.
• Each partner can be an expert
in a particular segment thus
adding more value to the
business.
• In the presence of solvent
partners, partnerships are
more likely to expand in the
long run.
Disadvantages
• Partnerships often find it
difficult to implement any
decision specially when
ideological conflict arises
between partners.
• Like sole traders all partners
suffer from unlimited liability.
• Legal limits on the number of
partners makes it difficult to
raise major finance.
• Profit sharing can prove to
inequitable if partners do not
have equal investments.
Private Limited Company
Advantages
• It is easier to raise finance from
shareholders relative when
compared to sole trader or
partnerships.
• Each shareholder enjoys limited
liability.
• Shareholders do not have to bear
the burden of running the business
and can appoint or elect directors.
• The business itself has a separate
legal identity. Thus firms legal
proceedings do not have any direct
impact on shareholders.
Disadvantages
• Financial statements must be
disclosed to all shareholders
following independent audit by an
external body. These can often
prove to be expensive.
• Private limited companies can not
offer shares for sale to anonymous
individuals. This limits the
businesses ability to raise capital.
• Owners cannot exercise full
authority over business operations.
• Firms might experience higher
administrative costs following
recruitment of directors and
managers.
• The maximum number of
shareholder is limited to 50.
Public Limited Company
Advantages
• Finds it easy to raise capital for
investment as shares can be offered
to the general public through a
stock exchange.
• Shares offered for sale can be
advertised to attract credible
investors.
• Considered to be the most stable
form of business organization by
financial institutions. This further
enables the firms to raise capital.
• Can expand through mergers or
takeovers.
Disadvantages
• Forming a public limited company
involves significant legal and
administrative expenditure.
• Public limited companies are under
the legal binding of disclosing all
financial activities publicly.
• Public limited companies are also
vulnerable to mergers or takeovers.
• There is frequent divorce between
ownership and control. Conflicts
between the owner body and the
management body can prove to be
harmful for the business.
• Larger shareholders enjoy greater
voting rights and can often subdue
the interest of smaller share
holders.
Multinational Companies
Advantages
• Gain access to a larger global
consumer base.
• Bypass all forms of trade barriers
usually imposed by a country’s
government on imports.
• Engage in global sourcing to gain
access to cheap raw materials or
labour.
• Enjoy tax benefits from a host
country as the firm creates
employment in the economy.
• Enjoy better access to technology
developed across different
countries.
Disadvantages
• Firms might be subject to stricter
rules and regulations in different
countries.
• Firms might need to customise
products with respect to the market
in which they operate. This can
raise overall costs.
• Firm’s culture and the host
country’s industrial culture might
conflict with each other. This can
disrupt operations.
• Local firms have a tendency to free
ride on the MNCs R&D investments.
Cooperatives
Advantages
• In worker cooperatives since
workers themselves are owners the
motivation to work is high.
• Cooperatives also share profits with
members either arbitrarily or
depending upon the amount
invested by each member. This
profit incentive works as driving
force.
Disadvantages
• Worker cooperatives or any other
form of cooperative usually fail to
gather finance and thus expansion
is difficult.
• Members in the cooperative might
not add value through expert
insights or skills. This can render
the business obsolete with changes
in market dynamics.
• Cooperatives might also suffer due
to a lack of profit motive and larger
focus on the welfare of members.