You are on page 1of 19

UTILITY AND DEMAND

Utility is a measure of the value which consumers of a product or service place on that product or service; Demand is a reflection of this measure of value, and is represented by price per quantity of output;

PRICE

QUANTITY ( OUTPUT )

PRICE a

Price equals some constant value minus some multiple of the quantity demanded: p=a-bD

QUANTITY ( OUTPUT )

PRICE a

Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function;

QUANTITY ( OUTPUT )

PRICE a

Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a p) / b QUANTITY ( OUTPUT )

PRICE a

Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a p) / b

REVENUE

QUANTITY ( OUTPUT )

Total Revenue = p x D = (a bD) x D QUANTITY ( OUTPUT )

PRICE a

Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a p) / b

PRICE

QUANTITY ( OUTPUT ) Total Revenue = p x D = (a bD) x D =aD bD2 QUANTITY ( OUTPUT )

PRICE a

Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a p) / b QUANTITY ( OUTPUT ) MR = dTR / dD = a 2bD = 0 Total Revenue = p x D = (a bD) x D =aD bD2 QUANTITY ( OUTPUT )

PRICE

PRICE a

Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a p) / b QUANTITY ( OUTPUT ) MR = dTR / dD = a 2bD = 0 Total Revenue = p x D = (a bD) x D =aD bD2 QUANTITY ( OUTPUT )

PRICE

MR=0

PRICE a

Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a p) / b QUANTITY ( OUTPUT ) MR = dTR / dD = a 2bD = 0 Total Revenue = p x D = (a bD) x D =aD bD2 QUANTITY ( OUTPUT )

PRICE

MR=0

TR = Max

PRICE a

Price equals some constant value minus some multiple E > 1 of the quantity demanded: p=a-bD E = 1 a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; E<1 D = (a p) / b

PRICE

MR=0

QUANTITY ( OUTPUT ) MR = dTR / dD = a 2bD = 0 Total Revenue = p x D = (a bD) x D =aD bD2 QUANTITY ( OUTPUT )

TR = Max

Cost / Revenue

Marginal ( Incremental) Cost


Profit is maximum where Total Revenue exceeds Total Cost by greatest amount

Maximum Profit

Marginal Revenue Cost / Revenue Profit

Quantity ( Output ) Demand Ct Total Revenue

Cf D1 D* D2 Quantity ( Output ) Demand

D1 and D2 are breakeven points

PROFIT MAXIMIZATION D*
Occurs where total revenue exceeds total cost by the greatest amount; Occurs where marginal cost = marginal revenue; Occurs where dTR/dD = d Ct /dD; D* = [ a - Cv ] / 2B

BREAKEVEN POINT D1 and D2


Occurs where TR = Ct ( aD - bD2 ) = Cf + (Cv ) D

- bD2 + [ (a - Cv ] D - Cf Using the quadratic formula:


2

D =
-----------

- [ ( a - Cv ] + { [ (a - Cv ] - 4(4(- b ) ( - Cf ) }1/2 ------------------------------------------------------------2 ((- b)

A Cost Revenue Model Approach


A popular application of Breakeven (BE) is where cost revenue volume relationships are studied; We define cost and revenue functions and assume some linear or nonnon-linear cost or revenue relationships to model; One objective: Find a parameter that will minimize costs or maximize profits termed QBE.

Cost Models Fixed Costs


Fixed Costs Cost that do not vary with production or activity levels
Costs of buildings; Insurance; Fixed Overhead; Equipment capital recovery; etc.

Variable Costs
Costs that vary with the level of activity;
Direct Labor wages; Materials; Indirect costs; Marketing; Advertising; Warranty; Etc.

Fixed Costs
Essentially constant for all values of the variable in question; If no level of activity, fixed costs continue; Must shut down the activity before fixed costs can be altered downward; To buffer fixed costs one must work on improved efficiencies of operations.

Variable Costs
Variable Costs change with the level of activity; More activity greater variable costs; Less activity lover variable costs; Variable costs are impacted by efficiency of operation, improved designs, quality, safety, and higher sales volume.

Total Costs
Total Cost = Fixed Costs + Variable Costs; TC = FC + VC; Profit Relationships; Profit = Revenue Total Cost P = R TC P = R {FC + VC}.

Cost Revenue Relationships


Linear Models; NonNon-linear models; Linear and nonnon-linear models are used as approximations to reality; A basic linear Cost Relationship is shown on the next slide.

Figure 1616-1

Linear and nonlinear revenue and cost relations used in breakeven breakeve n analysis.

Basic Cost Relationship (Linear)


C O S T

Total Costs

Variable Costs

Fixed Costs ( level)

Q Level of Activity per time unit

Breakeven
The breakeven point, QBE is the point where the revenue and total cost relationships intersect: For nonnon-linear forms, it is possible to have more than one QBE point.

Breakeven
Revenue and Total cost relationships tend to be static in nature; May not truly reflect reality of the dynamic firm; However, the breakeven point(s) can be useful for planning purposes.

Reduction of Variable costs

BE point Changes When the VCs are Lowered.

Figure 1616-2

Effect on the breakeven point when the variable cost per unit is reduced.

You might also like