Revenue, Cost, and Profit

Hey guys, so maybe some of you have that entrepreneurial spirit and want to start a business when you get out of school. Well, this chapter is gonna show you a lot of the decisions that firms have to make on the day to day related to profit and revenue and cost. So let's dive in. We're gonna start here and talk about revenue and we're gonna make our way down to profit. Okay, So let's start with revenue. And when we're in this unit, when we're gonna be talking about just one firm up to now, we've been talking about society as a whole. We've been looking at markets, right? The demand and supply in certain markets. Now we're just gonna look at one firm, right? One supplier. What what are their decision related to revenue, cost and profit? Right. So most of our time is going to be spent on cost. But revenue is definitely an important part of the decision making profits process. So let's go ahead and knock revenue out of the way. We've talked about revenue before, right? And revenue is the amount of money received from sales, right? It's the money that's coming in. And we said total revenue easy enough is going to be equal to the price times the quantity. Right? So how much you sell for, how much you multiply those and you're gonna get your total revenue. And remember this has nothing to do with cost. This is just the money coming in, right? Revenue is just money coming in without any regard to what it costs you to make it. Who? So when we talk about revenues and when we're talking about just one firm, the revenues are going to be the benefits to the firm, right? We've been talking a lot about benefits and costs. Well, when we talk about, uh, for for a firm, those revenues, the money that comes in, that's the benefits, that's why they're in business, right, is to get these benefits to get that revenue. So let's go ahead. And revenue is pretty simple. So we just got a simple example here and then we're gonna move on to cost where we're gonna be spending most of our time. So let's go ahead and do this this example in the year 2022, the price of Soylent green is 500 space credits. If a company sells 25,000 units of soil and green per year and the cost of producing Soylent green is 100 space credits per unit. What is the total revenue. So if you guys haven't seen this sci fi thriller, Soylent green from the 70s is a pretty good movie. It's pretty cheesy. But I like it and made a good example here. So they're asking us to calculate total revenue. Right? And we said total revenue is just gonna be the price times the quantity. So what did they give us here? They told us the price of Soylent green is these 500 space credits. And that the company sells 25,000 units right there selling 25,000 units of the soil and green. But they also told us that the cost of producing Soylent green is 100 space credits. Right? So, we've got the cost. We've got the price and the quantity. So remember when we're talking about revenue, cost. Doesn't matter at all. Right. We're just thinking about the money that's coming in. So this cost of producing Soylent green, That's extra information. It's irrelevant when we're thinking about revenue, Right? So, our answer here, it's gonna be pretty simple. We're just gonna take the price times the quantity, Which is equal to the price of 500 space credits times the quantity of 25,000 units. We do that math. And we're gonna get um 12,500,000 space credits. Right. Sc that's how in the future we abbreviate space credits is just sc so 12,500,000 space credits. That's gonna be our revenue, right? Revenue is pretty simple. We've dealt with this stuff before. Let's go ahead and move on to cost. Alright, let's do that in the next video

Alright. So when we talk about cost, we're talking about the inputs, right, what does it cost us to create this output? What what is the cost of the inputs into the production? Right? When we talk about cost, right? The revenues where the benefits to the firm? Well, the costs are going to the cost to the firm, right? That sounds a little redundant, but Right. We've been talking about benefits and costs pretty much throughout every uh unit that we've done in this course. So here, I'm just clarifying that the benefits are going to be that revenue and the cost is gonna be the cost, right? So, right now we're gonna define costs between this explicit and implicit. Okay, But after we do this, because we're going to do it this way to be able to calculate profit in certain ways. But after we do it this way, we're going to start talking about cost in a different way. The reason we're doing this is because it's very common. Easy exam questions where they ask us to calculate certain types of profit, accounting, profits, and economic profit and to do that, we need to talk about explicit and implicit costs, but like I said, after we learn how to calculate profit like this and do some practice, we're gonna talk about costs in a whole different way again. Alright, so this is one way to look at cost and let's start here with explicit cost. So an explicit cost is a cost that involves spending money all right. So you're gonna explicitly have this cost right, explicit is out in the open, Right? And that's what explicit means. So, you can tell how much this cost is, right? Because you're literally handing over money. So it's very easy to see that this cost exists because you handed over money for it, compare that to an implicit cost, right? It says here that they're non monetary. These are gonna be opportunity costs, right? Where there's no money being exchanged. You're not actually handing over money, but it is an opportunity cost. It's it's an opportunity that you gave up because you made this decision right now, quick note that these explicit costs. These are also opportunity costs, right? Because you have that money um that you spent, right? You explicitly spent some money on something, but you could have spent that money on something else, Right? So, the opportunity cost there is that that money could have been spent somewhere else. So, everything here is the opportunity cost. It's just that the implicit ones don't have actual money being spent. So, let's talk about some examples about what is going to be this explicit or implicit cost. Right? So, we're gonna talk about the idea of we've got Elon musk right? The Ceo of Tesla and SpaceX. He's smart dude. And he's making tons of money. But what we didn't know about him is that actually he didn't care about all this tech stuff. All he ever wanted to do was open a bakery and just make some cakes, right? But instead he started Tesla, he's exploring space, but in the back of his head, he's always thinking, man, I wish I started that bakery. And now all of a sudden he's like, you know what? Forget it all. I'm gonna start the bakery. So what are some of the explicit costs that Elon musk is gonna have when he opens up Elon musk cakes? Right, well, he's gonna have some standard stuff that he's gonna spend money on. Like uh you know, sugar for the cakes and flower, right, these kinds of standard things, right? You're gonna see him spending money, right? He has to pay money for these things. He's gonna have to pay wages right to his employees and rent, right? He's gonna pay rent something like that on on the building that he's renting, right? These are all explicit because he's spending money, you can actually see the money going out, right, compare that to some implicit cost of his business. So to him, one of the opportunity cost was this salary that he was making as ceo, right? He was making a salary as ceo of Tesla and now he gave up that salary to start his bakery, right? So that salary is an implicit cost of this business. He gave up the opportunity to earn that salary when he opened the bakery, right? So he's gonna have to consider that as an implicit cost of his business. Another very common one that they like to use in their examples is the is foregone interest, so foregone interest um when you, when you buy capital investment, so let's say Elon musk had $300,000 in the bank that he took out to buy equipment right to bake his cakes. He bought ovens, he bought all sorts of equipment for his, for his bakery. Well that $300,000 that he took out of the bank, it was earning interest in the bank, right? There was some interest rate and he was getting some money in interest for having that saved up. Now when he took it out of the bank, he's no longer earning that interest. Right. So he gave up that interest to start this business. So these are two of the most common implicit costs. You're gonna see when you have to do practice problems is that this person is usually gonna be skilled at something else. So they gave up a salary and when they start the business they're gonna have to take take money out of savings, they're gonna have to give up some interest. Right? So that's what you're gonna see generally when we talk about implicit cost explicit are usually easier to see, right? It's going to be things that they're just spending money on. Cool, so a quick note here about these implicit costs before we move on, is that there is a number amount, right? There was a dollar amount of his salary, right? Maybe he was making $300,000 as the Ceo of Tesla That he gave up. But remember it's non monetary, he didn't have to pay someone $300,000 when he quit the job and started the bakery. Right? It's an opportunity cost because he didn't have to actually give up money for it. But it is something that he gave up, not necessarily in cash. Cool. So let's go ahead and move on to the next video where we're going to define the different types of profit that we're going to be calculating. Cool, let's do that now.

Alright, so, right here, at the bottom, we've got profit. This is gonna be um the culmination of what we've discussed about revenues and costs so far. So profit is gonna be the difference between revenue and cost, right? So it's gonna be revenue minus cost. All right. And I want to make a quick distinction now, because I've seen a lot of students struggle with the concept of revenue versus profit, right? Revenue, is that money you're bringing in without regard to cost? It's all the total money that came in from sales, and then when you subtract cost, that's what's left over, is the profit. Okay, So revenue and profit are not the same thing. Okay, Revenue minus cost is gonna equal our profit. So we're gonna calculate two types of profit in this class. The first one is our accounting profit. So this is what an accountant might think of profit, they're gonna take the revenues and they're gonna subtract the explicit cost, right? The things where we actually spent money, explicit costs, so that's gonna equal our accounting revenue, Just the revenue and the explicit cost. But us economists, right, we're gonna take it a step further, and we think about opportunity costs as well. Right? So we're gonna have revenues minus explicit cost minus, implicit cost, that's gonna be our economic profit, right? So the economic profit also takes into account these opportunity costs. Alright, So this is how we're gonna define it, we're gonna do some practice problems now where we're gonna calculate accounting and economic profit in different situations, but remember after this little lesson right now, we're gonna keep talking about cost, but we're going to talk about it in a different light. We're gonna redefine cost not as explicit or implicit. We're gonna use different terms and different ways to think about it. All right. So let's go ahead and do these practice problems about profit, and then we'll keep going on about cost after that. Alright, let's go on and do that now.

Fast Fingers Freddy gives banjo lessons for $50 per hour. One day, he spends 8 hours planting $100 worth of seeds on his farm. If the seeds yield $600 worth of crops, what is his accounting profit and economic profit?

• A. Accounting profit = $600; Economic Profit = $500
• B. Accounting profit = $500; Economic Profit = $500
• C. Accounting profit = $500; Economic Profit = $100
• D. Accounting profit = $0; Economic Profit = $100

Ricky Smooth opens up a hunch punch stand in his dorm room every Wednesday for two hours. He spends $40 on ingredients and sells $120 worth of hunch punch. In those same two hours, Ricky could have been a nude model for the art department earning $60. Ricky Smooth has an accounting profit of ________ and an economic profit of ________.

• A. Accounting profit = $60; Economic Profit = $20
• B. Accounting profit = $80; Economic Profit = $60
• C. Accounting profit = $80; Economic Profit = $20
• D. Accounting profit = $20; Economic Profit = $80

Sweetie Nick has dreamt of owning a candy store his whole life. Unfortunately, after a few wrong turns, Sweetie Nick finds himself stuck in a job he hates, earning a nice salary of $100,000, but he is completely dead inside. One day, Sweetie Nick is fed up and decides to quit his job and open a candy store. He takes his $300,000 savings, which were earning 5% interest, and buys a property downtown. In his first year, Sweetie Nick sells $220,000 worth of candy that he purchased for $80,000. He also paid utilities of $2,000 and hired a cashier that earned $16,000 throughout the year. What is Sweetie Nick’s accounting profit and economic profit?

• A. Accounting profit = -178,000 ; Economic Profit = -278,000
• B. Accounting profit = 122,000; Economic Profit = 7,000
• C. Accounting profit = 122,000; Economic Profit = 22,000
• D. Accounting profit = 22,000; Economic Profit = 0

Alright guys so like I said now we're gonna break up costs in a different way. Right before we are using explicit and implicit when we're gonna calculate that profit. But now we're gonna talk about cost as fixed costs or variable costs. Okay so fixed costs are costs that do not change as output changes. So as we make more and more units these fixed costs stay the same. They don't keep increasing as our output increases compare that to a variable cost. A variable cost is a cost that changes as output increases. All right. And we're gonna see some examples of that right now but before we do that I just want to say that when we talk about fixed costs we're gonna be using the acronym F. C. For fixed costs and variable costs. V. C. For variable costs. Right? Total cost is gonna be just the sum of fixed costs and variable costs. So it's just gonna be F. C. Plus V. C. Right? Our total costs are gonna be these fixed costs plus our variable costs. So let's go back to that idea of this Elon musk cakes right? He He quit his job to start a bakery. So what are gonna be some of the fixed costs that Elon Musk Cakes is gonna have first he's gonna have the rent on the building. Right? So if you think about the rent right let's say he pays $5,000 a month for his bakery right? For the space Where he has his bakery. Well that $5,000 a month. It's not gonna change based on how many cakes he makes, right if he makes one cake or he makes 100 cakes, he's gonna pay that same amount of rent regardless of how many cakes he makes that month. Right? So that rent is a fixed cost, it's gonna stay the same regardless of how many cakes he makes. Another one. That's gonna be a fixed cost is something like a bookkeeper's salary, right? If he hires a bookkeeper uh to take care of his business um that bookkeeper is gonna make the same amount of money when he's making one cake or he's making 100 cakes, right? That bookkeeper is gonna make the same weekly salary regardless of what the output is of the of the company. Right? So that salary is gonna stay fixed regardless of output. So let's consider some of the variable costs. Well some of the variable costs are gonna be those inputs that he puts uh directly into the cakes. Like the sugar and the flour. Right? So sugar and flour are gonna be some of our variable costs. You can imagine as he makes more and more cakes, he's gonna need more sugar and more flour uh to to make those cakes. Right? So it's gonna be things that are going up with the with the um amount of output that you make. Right? So things that increase with uh with output. Another common one is day laborers. Right? And we're gonna be dealing with this a little more as we go on. So the idea of day laborers, right? As he makes more and more cakes, he's going to need assistant chefs. Right? So you would imagine that is he makes some cakes, he starts making some cakes. He's gonna need an assistant as he makes more and more cakes. He's gonna need more and more assistance helping him in the kitchen. Right. So you'll see that these day laborers are variable costs. Right? As he makes more and more cakes, he's gonna need more and more of these day laborers to help him in the kitchen. Cool. So that's the difference between these fixed costs and variable costs. And now when we deal with these fixed costs and variable costs most of the time we're gonna be dealing with them as an average the average fixed cost is gonna be what is the fixed cost per unit? So to calculate an average um for an average cost, all we need to do is just divide by the quantity. Right? So we're gonna have an amount of fixed costs and we're gonna divide that by how many cakes we made? Right? If there was that $5000 fixed cost for the rent of the bakery, we can split that between how many cakes he made, Right? How much is it gonna, how much of that fixed cost is it per cake? So we're gonna have an average fixed cost which we're gonna call a F. C. For average fixed cost. A VC for average variable cost an A. T. C. For average total cost. Right? So these are gonna be calculated very easy. Right? We're just gonna have for fixed cost. It's gonna be our fixed cost divided by quantity. For variable costs. It's going to be variable costs divided by quantity. And guess what? For total cost? Well that's just gonna be total cost divided by quantity. Right? But another way we can think about total cost about our average total cost is that we could just say that it's the average fixed cost plus the average variable cost. Either of those is also going is that's also going to get us to our average total cost. Right? Because up above we define total cost as fixed cost plus variable costs. When we do a little bit of algebra we'll see that this ends up being the same answer. Right? So we can just take our total cost divided by quantity or if we have average fixed cost and average variable costs, we add those together to get average total cost. Cool. One last thing to discuss, uh before we move on, we're gonna be talking about two time periods in this class, there's gonna be the short run and the long run. Okay. And there's not a very distinct, this the short run is one year or the short run is three years or one month. It's gonna be different for every business the way we define the short run is the time period where at least one cost is fixed. Okay? So if we have any fixed cost, that means we're in the short run. Right? So what could be something that's fixed? Could be the size of our our factory, Right? The factory size in the short run, we're basically stuck with this factory, right? We built a factory and we're stuck with the restraint of this factory, we can only produce as much as this factory allows, Right? Um So in the short run, that's gonna be fixed. Another thing that's fixed is salaried employees, right? You might not be able to just fire these salaried employees uh in the short run, right, there gonna be a fixed cost of the business. So when we talk about the long run, compared to the short run, the long run is a time period where all costs become variable. So, if you think in a long enough time period, the size of the factory can be changed, right? If we think long enough, maybe right now we're stuck with this factory, but eventually we could demolish this factory, sell this factory, build a new one that's bigger, or build a new one that's smaller, right? We can change the size of the factory. So in the long run, The factory size ends up being variable, right, the amount we pay in rent becomes variable right now, we might have a lease, right? That least saying that we have to pay 5000 a month for this bakery. But in the long run, that lease is gonna expire right? We don't have that fixed cost anymore. We can reevaluate whether we want to have this current factory or want to build a new one. So we're gonna be able to change the factory size in the long run, right? We can we're gonna have that as variability, as a variable cost, change factory size, and we'll be able to fire salaried employees, right? If you, in the long run, we're gonna be able to reevaluate everything about our business, we can fire people, we can change our factory size, we can take all those fixed costs, and they'll be variable costs in the long run. Okay, So that's how we define time periods, right? It's not a distinct amount of time. Each business is gonna have a different short run and long run. It just depends on how how long it takes you uh to be able to treat your costs as variable costs. Alright, So that's it. Let's go ahead and move on to the next video

A short run cost function assumes that:

• A. The level of output is fixed
• B. All inputs are fixed
• C. At least one input is fixed
• D. Both (a) and (c)
• E. None of the above

A company currently has total costs of $4,096 when producing 128 units. If total fixed costs equal $1,024, what is average variable cost?

• A. $8
• B. $24
• C. $2,048
• D. $3,072
• E. None of the above

Rose incurs $7,200 per month in fixed costs operating her floral shop. She pays her employees $9 per hour and had three assistants working 120 hours this month. Her other variable costs were $800 this month. What are Rose’s total variable costs and total costs this month?

• A. Total variable costs are $800; total costs are $8,000
• B. Total variable costs are $800; total costs are $11,240
• C. Total variable costs are $3,240; total costs are $11,240
• D. Total variable costs are $4,040; total costs are $11,240