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    Aec 001-Bacc 001 (Econ) - Week 15 Module

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    Nicole Valentino
    This module focuses on distinguishing accounting profit from economic profit and explaining the revenue-output relationship using total revenue and marginal revenue. It discusses how profit is the difference between total revenue and total cost, and how firms aim to maximize profits by producing at the level where marginal revenue equals marginal cost. Accounting profit only considers explicit costs, while economic profit considers both explicit and implicit costs. [END SUMMARY]

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    Aec 001-Bacc 001 (Econ) - Week 15 Module

    Uploaded by

    Nicole Valentino
    60 views3 pages
    This module focuses on distinguishing accounting profit from economic profit and explaining the revenue-output relationship using total revenue and marginal revenue. It discusses how profit is the difference between total revenue and total cost, and how firms aim to maximize profits by producing at the level where marginal revenue equals marginal cost. Accounting profit only considers explicit costs, while economic profit considers both explicit and implicit costs. [END SUMMARY]

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    Aec 001-Bacc 001 (Econ)-Week 15 Module

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    This module focuses on distinguishing accounting profit from economic profit and explaining the revenue-output relationship using total revenue and marginal revenue. It discusses how profit is the difference between total revenue and total cost, and how firms aim to maximize profits by producing at the level where marginal revenue equals marginal cost. Accounting profit only considers explicit costs, while economic profit considers both explicit and implicit costs. [END SUMMARY]

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    60 views3 pages

    Aec 001-Bacc 001 (Econ) - Week 15 Module

    Uploaded by

    Nicole Valentino
    This module focuses on distinguishing accounting profit from economic profit and explaining the revenue-output relationship using total revenue and marginal revenue. It discusses how profit is the difference between total revenue and total cost, and how firms aim to maximize profits by producing at the level where marginal revenue equals marginal cost. Accounting profit only considers explicit costs, while economic profit considers both explicit and implicit costs. [END SUMMARY]

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    © All Rights Reserved
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    of 3

    MODULE 15: THEORY OF COST AND PROFIT (CONTINUATION)

     Profit Concept

    WEEK: 15

    TIME ALLOTMENT: 3 Hours

    OBJECTIVES/ LEARNING OUTCOMES:


    At the end of this module, the students are expected to distinguish accounting and economic
    profit and explain the revenue-output relationship using the total and marginal revenues.

    LEARNING CONTENT:

    THEORY OF COST AND PROFIT (CONTINUATION)

    Introduction

    We’ve explained the general concept of the theory of cost and profit and identified the different
    cost. A firm’s total costs depend on the quantities of inputs the firm uses to produce its output and the
    cost of those inputs to the firm. The firm’s production function tells us how much output the firm will
    produce with given amounts of inputs. However, if we think about that backwards, it tells us how many
    inputs the firm needs to produce a given quantity of output, which is the first thing we need to
    determine total cost.
    For every factor of production (or input), there is an associated factor payment. Factor payments
    are what the firm pays for the use of the factors of production. From the firm’s perspective, factor
    payments are costs.

    Discussion

     Profit Concept
    Profit – is reflected in reduction in liabilities, increase in assets, and/or increase in owners'
    equity.
    The firm's primary objective in producing output is to maximize profits. The production of
    output, however, involves certain costs that reduce the profits a firm can make. The relationship
    between costs and profits is therefore critical to the firm's determination of how much output to
    produce.
    The conventional theory of the firm defends profit maximization objective on the following
    grounds:
    * In a competitive market only those firms survive which are able to make profit. Hence,
    they always try to make it as large as possible. All other objectives are subjected to this
    primary objective.
    * Profit maximization objective is a time-honored objective of a firm and evidence against
    this objective is not conclusive or unambiguous.
    * Though not perfect, profit is the most efficient and reliable measure of the efficiency of a
    firm.
    * Under the condition of competitive market, profit can be used as a performance evaluation
    criterion, and profit maximization leads to efficient allocation of resources.
    * Profit maximization objective has been found extremely accurate in predicting certain
    aspect of firm's behavior and trends; as such the behavior of most firms are directed
    towards the objective of profit maximization.

    Accounting Profit vs. Economic Profit


    Accounting profits, economic profits, and normal profits. The difference between
    explicit and implicit costs is crucial to understanding the difference between accounting
    profits and economic profits. Accounting profits are the firm's total revenues from sales of
    its output, minus the firm's explicit costs. Economic profits are total revenues minus
    explicit and implicit costs. Alternatively stated, economic profits are accounting profits minus
    implicit costs. Thus, the difference between economic profits and accounting profits is that
    economic profits include the firm's implicit costs and accounting profits do not.
    A firm is said to make normal profits when its economic profits are zero. The fact that
    economic profits are zero implies that the firm's reserves are enough to cover the firm's
    explicit costs and all of its implicit costs, such as the rent that could be earned on the firm's
    building or the salary the owner of the firm could earn elsewhere. These implicit costs add
    up to the profits the firm would normally receive if it were properly compensated for the use
    of its own resources—hence the name, normal profits.

    Each of businesses, regardless of size or complexity, tries to earn a profit:


    Profit = Total Revenue – Total Cost
    Total revenue is the income brought into the firm from selling its products. It is
    calculated by multiplying the price of the product times the quantity of output sold:
    Total Revenue = Price x Quantity

    Total Revenue vs. Marginal Revenue


    Revenue is the amount of money that a business brings in by selling its goods or services
    at a certain price. It is the starting point of a company's income statement that determines
    how much net income it makes after expenses, taxes, and interest are taken into
    consideration. As such, it is one of the most important line items for a business.

    Although it may be one number, there are many different ways to look at it. These varying
    degrees of insight are helpful to businesses, analysts, and investors. Two of the most
    common forms of revenue are total revenue and marginal revenue. While total revenue
    represents the total amount of money earned by a business (sales multiplied by the prices
    of products and services), marginal revenue refers to the increase in revenue achieved by
    selling one additional unit of a product or service.

    1. Total Revenue (TR) – is the total amount that a firm takes in from the sale of its output.
    TR = P x Q
    Total revenue is important because businesses strive to maximize the difference
    between their total revenues and total costs as they try to grow profits. Understanding
    the subtleties of the relationship between revenues and costs distinguishes the best
    business managers from the lesser ones. That's because increasing production leads to
    an increase in sales and total revenue and there are also costs involved with increasing
    production.

    2. Marginal Revenue (MR) – is the additional revenue that a firm takes in when it increases
    output by one additional unit.
    In perfect competition, P = MR

    MR = change in TR/Change in Quantity

    Marginal revenue is important because it measures increases in revenue from


    selling more products and services. Marginal revenue follows the law of diminishing
    returns, which states that any increases in production will result in smaller increases in
    output. This means the optimal level has passed. As long as marginal revenue is above
    marginal cost, a company is making profits because it costs money to make and sell
    an additional unit. Once the marginal revenue equals marginal cost, it makes no sense
    for a company to produce or sell more units of its products or services.

    Comparing Cost and Revenues to Maximize Profit


    1. The profit-maximizing level of output for all firms is the output level where MR = MC.
    2. In perfect competition, MR = P, therefore, the profit-maximizing perfectly competitive
    firm will produce up to the point where the price of its output is just equal to short-
    run marginal cost.
    3. The key idea here is that firms will produce as long as marginal revenue exceeds
    marginal costs.

    Summary

    This module focuses on the profit concept or the revenue-output relationship using the total
    revenue and marginal revenue.

    REFERENCES:

    1. Pagoso, C., Dinio, R., Villasis, G. (2006). Introductory Microeconomics (Third Edition). Rex Book
    Store, Manila, Philippines.
    2. Kapoor, K.C., Soni J.C., Achrya, P.K., Riba, M., Riddi, A. (2016). Economic Theory. Vikas
    Publishing House PVT.LTD

    Congratulations on finishing Module 15! Keep up the good work.

    Prepared: Reviewed/Approved:

    JUVIELYN R. RAMOS AIZA P. RUMAUAC, CPA


    Instructor Program Head, Accountancy and Business Administration

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