Costs and RevenuesChapter 18 Section 2

Indicators used to decide how MUCH TO PRODUCE

SummerLet’s pretend you just

graduated from 7th grade.

Your parents were so happy that they gave you a graduation gift

It was your their way of encouraging you to get a job

How to Make a Glass of Lemonade

Step 1 – Cut Lemon in half, squeeze into cup with ice in it.

Step 2 – Add two scoops of sugarStep 3 – Add WaterStep 4 – StirStep 5 – Enjoy!

A Trip to the ACME

What is on our Shopping List?

–Lemons–Cups–Ice–Sugar

What are some other expenses?

RentWorkersInfrastructure (investments)

What is Cost?

The amount of $$$ coming out of your pocket when you are producing goods and services.

“Unit” – a term used to describe the “goods and services”

ex: Bicycle Helmet, DVD, Wheat, Cup of Lemonade, etc

Fixed Cost

When costs are the same no matter how many units of a good are produced.

Rent and Taxes…

Variable Costs

Costs that Change with the number of units produced…

Ex: Wages and Raw Materials

Increase as production grows…and Decreases with a productivity decreases…

Total Costs

Fixed Costs + Variable Costs= Total Cost

Also…. “Average Total Cost”

With all of your variable costs changing….it is hard to tell how much money you are making…Average Total Costs would be Total Cost divided by # of units sold.

Marginal Costs

Marginal Cost is the amount of money that it takes to produce one more “unit”.

We will look at this in a minute….

Business is Booming

Revenue

The amount of $$$ that comes into your pocket after you are done producing goods and services

• Total Revenue and Marginal Revenue

Total Revenue

The Number of Units sold…multiplied by the price per unit.

Sold 42 glasses of Lemonade, at $1.00 a pop…

Your total revenue is $42.00

This number doesn’t include _________.

Marginal Revenue

The change in total revenue from selling another “unit”

Reminds us of Marginal Cost which was…. the amount of money that it takes to produce one more “unit”.

Marginal BENEFIT

Marginal Revenue - Marginal Cost = The Marginal Benefit

If we want to find the “Marginal Benefit” – we would look at the Cost-Benefit Analysis

Cost Benefit Analysis

Weighing the Marginal BENEFITS against the Marginal COSTS….

Helps us decide how much to produce….

If the COSTS outweigh the BENEFITS…we lose money.

ACME Lemon Prices

• 1 Lemon = .33 cents• 10 lemons = $2.50• 20 lemons = $4.00• 40 Lemons = $6.00

How does this explain Marginal Cost?

Lets say you bought a case of 40 lemons

You got a lemon for 15 cents… add 3 cents worth of sugar…a 10 cent cup…and free water…. 28 Cents.

Sold for a dollar.

Profit? 72 cents. Not bad.

Lets say a 41st customer walked up…

You don’t have any more supplies…..

ACME

You run to the Acme….buy a lemon for 33 cents.

WaWa

Run into wawa and buy a cup of ice for 75 cents

Dunkin Donuts

They won’t give you any sugar for free, so you need to buy 2 sugar packets for 15 cents.

So your 41st Lemonade cost:

$. 33 lemon$. 75 cup/ice+ $. 15 sugar$1.23 (Marginal Cost)

you sold it for $1.00

Lost 23 cents

It wasn’t worth making one more “unit”

(Marginal Benefit was -23)

After doing a Cost Benefit Analysis for our Lemonade Stand – we found out that Our Marginal COST did not outweigh the Marginal Benefits….therefore….

We should have turned away the 41st customer.

What NEXT?

What are some ways we could increase our profit?

• What are some ways we could increase our production?

• What are some ways we could decrease our Costs?

Average Customers (by hour) June 2008

• 9:00 – 10:00 - 5• 10:00 – 11:00 - 6• 11:00 – 12:00 - 16• 12:00 – 1:00 - 32• 1:00 – 2:00 - 14• 2:00 – 3:00 - 18• 3:00 – 4:00 – 6• 4:00 – 5:00 - 2