Firms' costs, revenues and objectives

Costs:

Cost is essentially cost of production. It is from the producers angle as to how much they spent to produce the product. There are different types of costs.

Variable Costs: Variable costs are the costs that keep changing in relation to the change in the amount of output. It is directly proportional to the amount of output produced. An increase in the amount of the output increases the variable cost and these are incurred on the variable factors of production

• Cost of the raw materials

• Cost incurred on the other inputs required for production

• Transportation cost is also a variable cost

Fixed Costs: Fixed cost means the cost incurred by the business on the fixed factors of production Incase of a fixed cost, these costs will never change with the change in the amount of output. Fixed cost will never be zero and is a straight horizontal line. Examples include rent, electricity bill.

Total Cost: Total cost = fixed cost + variable cost

Average Cost Curve: Average cost or average total cost curve looks like the alphabet U. It has two different slopes. At the initial stages of production the output is increasing thus at the initial production level of the firm the average cost starts declining at the beginning. The fixed cost remains constant thus carries the burden of the total output. Causing the U shape. After a point, it becomes difficult to maximise output thus the average cost increases and the curve rises. The point is the minimum average cost. In the beginning the output is more.

Total Cost / Number of units produced

Total Cost Curve: The total cost curve runs parallel to the variable cost curve. Change in variable will be caused by a change in the total cost.

Fixed Cost + Variable Cost

Average Fixed Cost: Average fixed cost curve is downward sloping.

Total Fixed Cost/Output

Profit: When total revenue exceeds total cost a firm makes profit. Profit is basically the difference between total revenue and total cost. When total revenue > total cost the firm is making a profit.

Total Revenue - Total Cost

Loss: Loss is total cost - total revenue

When the total revenue < total cost the firm is making a loss

Revenue:

Revenue is the income of the producer. The amount the firm gets after sales is called its sales revenue or sales preceit. Sales revenue is also known as turnover.

3 types of revenue

• Marginal Revenue

• Total Revenue

• Average Revenue

Total revenue: Total earning of the producer. It is the number of units sold * market price. Total sales of a firm based on a given quantity of goods. It's the Quantity * Price.

Average revenue: Average revenue is the unit price. Average revenue is the price of the product

Marginal revenue: It is the additional income earned by the producer by selling an additional unit of product

Marginal revenue is the income earned by the producer by selling an additional unit of output in the market.

Marginal revenue = (n+1)- total revenue

Breakeven: It is a situation when the company's total revenue is equal to the total cost. It indicates that the company neither makes loss nor profit

Fixed cost / (average revenue - variable cost)

Supply-Side Policy:

A supply side policy is a government macroeconomic policy designed to increase aggregate supply and therefore boost productive potential of the economy . This aims to increase the rate of economic growth and helps reduce inflationary pressures such as increase in demand and high prices. This policy removes barriers to increase employment and attain greater levels of productivity. It also acts as an incentive for firms to increase their productive capacity and therefore increase their overall output. This policy includes:

• targeted public expenditure: where a government provides subsidies to firms in order for them to fund their research and development to attain more efficient production processes and innovate better quality products.

• targeted tax changes: that are used to reduce taxes on wages and profits to increase rewards for enterprise and labour.

• New regulations and Reforms is also a supply side policy that deals with the introduction of rules to outlaw unfair and anti-competitive practices by dominant firms of the market.

This policy influences the behaviour of producers and consumers in a particular market to help the government achieve its macroeconomic aims.

Furthermore, this policy invests in the training and education of labour to increase productivity and make firms more efficient to maximise output. This policy also reduces the power of trade unions to ensure that labour doesn't have the bargaining power to increase wages in order to reduce unemployment.

Demand-side Policy:

Demand side policy is another government macroeconomic policy that aims to influence the level of total demand in an economy. Demand-side policy influences the aggregate demand in an economy while influencing the output, employment and inflation. There are various demand-side policies such as fiscal policy and monetary policy. It does so by using a number of policy instruments such as:

• total public expenditure; by influencing the disposable income of individuals

• the overall level of taxation such as indirect taxes on goods and services that is passed on the consumer's which increases prices of goods and services and leads to a decrease in demand. Another tax is the income tax that affects the disposable income of people in the economy.

• The rate of interest is by regulating the monetary policy to decrease or increase spending in an economy.

This policy is used depending on the amount consumers spend on goods and services. taxes on profits will also affect people's incentive to start their own businesses from having to invest in new capital equipment and expanding the scale of production. increasing public expenditure will boost demand and therefore stimulate higher output and employment in an economy, rise in interest rates force consumers to save more and borrow less that for decreasing public expenditure on goods and services this will encourage investment from overseas. Taxes and public spending can be used by the government to redistribute income and wealth from rich people to the poor people.

Objectives of a Firm:

Profit Maximization: To earn a profit, firms must generate more revenue from their productive activities than the cost to carry out. The ability to make a profit is a factor reward that motivates many entrepreneurs to set-up firms. Profit maximization involves using factors of production and allocating them in the most efficient way so as to make the greatest amount of profit possible. However, Profit maximization can be difficult and take many years to achieve. Before a firm can increase its profit it may first need to increase its total sales and market share of the product it supplies. They may only be able to achieve this by spending a large amount of money on developing and advertising the product. To increase sales and market share the firm may have to spend a large amount of money on developing and advertising its product . It may also have to sell its product at a low price in the market to attract consumers. All of these actions will initially reduce the profit and many firms may have to undergo losses for a long time. Therefore most private sector firms aim to achieve long run profit maximization. Firms earn profits and put them towards investments such as reinvesting in their own company (Earning more profits helps firms ensure that they are financially stable. The firms wanted to have more profit to motivate themselves. Inorder to gain a reputation and to be recognised thus they need to maximise profit. Profit maximisation of a firm is the point where marginal revenue is equal to the marginal cost. At that point profit maximisation output is produced.) Contrastingly some entrepreneurs may just want a satisfactory amount of profit so they can put some into the company and use some to buy and enjoy the goods and services they want.

Growth: One of the key objectives of a firm is to grow. A firm can grow internally or externally through Merger or take over. A firm plans to grow by increasing its market share, sales and scale of production. Growth is expensive and difficult to achieve but boosts a firm's profit in the long run. Firms are also able to enjoy the advantages of economies of scale. It is easier for a firm to grow if the demand for its product is rising. If demand is rising, a firm will tell it to increase its scale of production by employing more resources and decrease its price to attract consumers away from rival firms.

• The business grows to ensure that they can survive in the competitive market

• As they can increase market share if they grow

• To enjoy the benefits if economies of scale in the long run

• To generate more revenue

• A company grows to diversify to spread the risk

Survival: Starting and running a new firm can be difficult, the setup cost can be high, consumer tastes and spending patterns can change extremely quickly and competition from large businesses can be fierce. Many new firms close within the first year of operation. Survival is therefore the most important objective for newly created firms. However, it is also an important objective for established firms during economic recessions as unemployment rises and consumer spending falls for many goods and services, many firms are forced to close during the economic recession new technology can change many production processes and product design therefore production sales and profit targets may need to change similarly new source of competitions from new startups of firms located overseas can cause an established firm to rethink or change its objectives for example it may have to cut its prices and earn less profit in order to compete for sales and maintain its market share.

Social welfare and Environmental objectives: Many firms are led by social entrepreneurs who organise resources in various economic activities to address environmental and social issues. They are not profit oriented firms and usually invest in themselves and their activities to help attain their goals. Examples of such firms include social care, health care, education, renewable energy, recycling. Their objective is to attain social and environmental wellbeing rather than maximizing profit are usually financed and organised as sole traders, charities, partnerships etc.

Pricing Strategies:

Predatory Pricing (Destruction Pricing)

In the event an existing firm sees new firms entering the market, the existing firm reduces their price so much that some small sellers cannot afford to stay in the market anymore or incur so much loss that they cannot continue producing their product. This strategy is used by dominant forms in the market when they are threatened by the arrival of small firms or increasing competition. However this strategy can result in a price war if competitors respond to a decrease in price by cutting their own prices. This may lead to firms getting into a price war as they try to undercut the prices of their rivals. Many firms end up losing a lot of money if they decrease their prices to an amount that isn't profitable.

Price leadership/follow-the-leader pricing

One seller will set the price and others will follow. Either of the following two types of sellers decided the price. First - the seller who always makes profit. Other firms understand that this firm must be doing something right/pricing their products efficiently and so choose to follow this. Second - the seller who has a long experience in the market. Other firms trust this firm since they have a history in the market of the product and the firm also knows ups and downs of the market and has faced many adversities.

Product Differentiation:

Product differentiation is when firms supplying similar or homogenous products, compete on non-price factors to attract consumer demand. Please non-price factors include brand name, image shape, taste, smell, colour, durability and warranty periods. Examples of such competition could be soap, deodorant, laundry detergents etc. these products are supplied in the same market but make different claims about the quality of the product to attract consumer demand. In this market if a firm is able to attract consumer demand by claiming that its product is most superior it can regulate the price by charging higher prices to the consumers to make greater profits. This competition is mainly focused on the product features.