Chapter 11: Calculating Costs, Revenues and Profits

Price
 
Definition: the amount paid by a consumer to purchase 1 unit of a product.
 
A business must set a price that is:
- High enough to cover the costs of making the product
- Low enough to attract customers

 
Total Revenue
 
Definition: A measure of the income received from an organisation's activities.
 
Total Revenue= Quantity of units sold  x  Price per unit
 
Also called: Income, revenue, sales revenue, sales turnover or turnover.
 

Profit
 
Definition: The difference between the income of a business and its total costs.
 
Profit= Total Revenue - Total Costs
 
Ways to improve profit:
- Increase sales revenue
- Decrease Costs
 

Costs
 
1. Total Costs Definition: The sum of fixed costs and variable costs
 
Total Costs= Fixed Costs +  Variable Costs
 

2. Fixed Costs Definition: Costs that DO NOT VARY directly with output in the short run (e.g. rent)
 
Fixed Costs: Machinery, Rent and rates, Salaries, Administration, Vehicles, Marketing, Lighting and heating

 
3. Variable Costs definition: Costs that DO VARY directly with output in the short run (e.g. raw materials)

Variable Costs: Raw materials, Wages of operatives/direct labour, Power

Wages and salaries?

Wages are paid to operatives who make the product - measured per hour - a variable cost

Salaries are paid to staff who are not directly involved in production - measured per annum - a fixed cost


Semi-variable costs

Semi-variable costs are costs that combine elements of fixed and variable costs.

Example: A worker may be paid a set wage plus a bonus for each extra item she produced.
The set wage is a fixed cost and the bonus is a variable cost.



Effect of changes in Output on Costs

The total costs are rising at a slower rate than output because only the variable costs are increasing as output increases.

When output changes by a certain %, the total variable costs will change by the same %.



Relationship between costs and price 

In lots of industries, increases in costs are 'passed on' to consumers in the form of higher prices. 
These costs could be raw materials for example.
Business theory says this would lead to a fall in demand (and possibly sales revenue).
But demand is less likely to fall if every business increases its prices. This is likely when all firms are affected in the same way.
All firms will want to try and maintain a PROFIT MARGIN.

Profit Margin is the difference between the selling price of the item and the cost of making/buying that item).