Revenue Structure, Objectives of a Firm and. Break-Even Analysis.

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1 Revenue :The income receipt by way of sale proceeds is the revenue of the firm. As with costs, we need to study concepts of total, average and marginal revenues. Each unit of output sold in the market fetches a price and when this price is multiplied by the number of units sold we obtain total revenue. TR = P x Q ; where P is Price; Q units of product sold and TR Total Revenue.

2 As with costs, we need to study concepts of total, average and marginal revenues. Average Revenue is the revenue derived by the firm per unit of its output sold. AR = TR Q ; but TR = P x Q ; hence P x Q AR = or AR = P. Q Thus average revenue is nothing but price of the product.

3 As with costs, we need to study concepts of total, average and marginal revenues. Marginal Revenue is the additional revenue from selling additional unit of output. MR nth = TR n - TR n-1 or MR = ΔTR ΔQ

4 Relation among TR, AR and MR The revenue structure of a firm is dependent on the competition in its market. Under perfect competition, it is one of many players and does not have any influence on price and therefore revenue. Revenue structure under monopoly or oligopoly ( that market category in which there is competition among few sellers ) is quite distinct.

5 Relation among TR, AR and MR A The revenue structure of a firm under perfect competition. Perfect competition is marked by presence of infinite number of firms producing homogeneous product. A single firm s contribution to total supply available in the market is insignificant. The firm under perfect competition can neither influence the price nor the output in the market. It is thus a price taker and not a price maker.

6 Relation among TR, AR and MR A The revenue structure of a firm under perfect competition. It is thus a price taker and not price maker. Its AR curve (see next graph) explains the price and output relationship and is thus also demand curve of the firm. It is important to note that the demand curve of the firm is different from the industry demand curve.

7 Relation among TR, AR and MR A The revenue structure of a firm under perfect competition. TR, MR, AR under Perfect Competition Revenue in Rs, Quantity in Units AR + MR TR

8 Relation among TR, AR and MR A The revenue structure of a firm under perfect competition. The industry demand curve is downward sloping, i.e. it slopes downwards from left to right indicating that for Industry to sell more of its output the price should be low. But the firm s demand (representing much smaller quantity) curve is horizontal as it sells whatever number of units at a price decided by market demand & supply forces.

9 Relation among TR, AR and MR A The revenue structure of a firm under perfect competition. Industry Demand Curve 1000 Price (Revenue) price S S1 D D1 price Quantity Million Units

10 Relation among TR, AR and MR A The revenue structure of a firm under perfect competition. Firm's Demand Curve Price (Revenue) D= AR = MR Quantity Thousand Units

11 Relation among TR, AR and MR B The revenue structure of a firm under Monopoly Monopoly is that market category in which a single seller dominates the market. There is only one producer firm and there are no substitutes to its products. There is no element of competition. Firm itself is an industry. Naturally the firm is not a price taker but a price maker.

12 Relation among TR, AR and MR B The revenue structure of a firm under Monopoly Naturally the firm is not a price taker but a price maker. As he wants to sell more & more, he needs to drop the price lower. Total revenue increases but at a diminishing rate. AR goes on falling, MR too is falling. But marginal revenue is falling at a rate faster than the average revenue as seen in the next diagram.

13 Relation among TR, AR and MR B The revenue structure of a firm under Monopoly AR & MR Y Revenue O Units MR AR X

14 Relation among TR, AR and MR B The revenue structure of a firm under Monopoly AR & MR AR curve under monopoly slopes downwards from left to right. MR curve lies below AR curve, and MR curve is steeper than the AR curve

15 Relation among TR, AR and MR B The revenue structure of a firm under Monopoly AR & MR AR curve under monopoly cannot cut X-axis, but MR curve can. If AR curve cuts X-axis, price for all units will be zero and there will be no revenue, which is absurd. But after selling a good amount of units at a good price, producer can sell a few units free, i.e. at zero price and still make money.

16 Relation among TR, AR and MR B The revenue structure of a firm under Monopoly AR & MR Revenue If AR curve under monopoly is a straight line, then MR lies exactly half way between AR and X-axis. PR = PS P R S MR AR

17 Relation Between AR, MR and Elasticity of Demand These three are closely related. In the next graph Demand function is DD 1 Elasticity at point T on DD 1 is D 1 T E d at T = DT And the relationship is Average Revenue E = Average Revenue Marginal Revenue

18 Objectives of a Firm Normally, the objective of the firm is to maximize profits. But it is not the only one or most important one. Satisfactory Return. Psychic Income. Gaining Reputation as a good businessman. Serving Quality Product. Maximizing Sales. Long Run Survival. Avoidance of loss. These also are a few more objectives we discuss now

19 Objectives of a Firm A. Profit maximization :- The price output policy of the firm is so adjusted that the firm should earn maximum profits. In reality firms rarely work to maximize profits. This is due to if firm maximizes profits, rival producers are attracted. public / the government may get antagonized can harm goodwill of the company other qualities of life are lost

20 Objectives of a Firm B. Sales Maximization Firms strive to maximize sales revenue subject to the realization of some minimum level of output. Sales maximization under a profit constraint does not mean an attempt to obtain the largest possible physical volume. Rather, it refers to maximization of total revenue which, to the businessman, is the obvious measure of the amount he has sold. This has emerged as one of the most realistic objectives of the firm.

21 Objectives of a Firm C. Quiet Life and Stable Profits. This objective emphasizes secure and stable profits. The best of all monopoly profits is a quiet life. There is another motive which cannot be so lightly dismissed and which is probably of similar order of magnitude as the desire for maximum profits : the desire for secure profits.

22 Objectives of a Firm D. Long-run Survival and Growth This objective emphasizes keeping down of prices for a short term to retain the goodwill of the customers. The best way for long run profit is to survive in the short-run. After overcoming the teething trouble of mere survival, firm then derives growth. Long run survival and growth have been regarded as other alternative objectives of the firm.

23 Objectives of a Firm E. Growth Maximization This objective aims at maximizing the growth and promoting security of the firm. This steady growth model is preferred to meet rising expenses and thereby ensure the market value of the firm s shares in stock markets.

24 Objectives of a Firm F. Other Alternative Objectives Balance Sheet Homeostasis firm wishes to maintain certain accounting ratios for an equilibrium of the balance sheet. Behavioral Theory in addition to profits, firm has additional goals of production, inventory, sales and market share. Utility Index Theory objective is to achieve a set of well defined ordered preferences. Includes Satisfaction and Staff maximization.

25 Objectives of a Firm Conclusion:- Neither of these approaches, however, has yet produced an alternative which has sustained enough recognition to replace traditional theory of firm. Neo-classical theory somehow manages to stand as the principal model of the firm s output, cost and price behaviour.

26 Break-even point is defined as that point where the level of output is so reached that TR = TC and hence net income is zero. Even though profit maximization is the ultimate goal of a firm, it starts incurring costs first. As sales increase the revenue starts covering the costs. Break- even volume is the number of units of product that must be sold in order to generate enough revenue just to meet all expenses, both fixed and variable.

27 From the next diagram, it can be observed that until point OQ, total cost TC is more than total revenue TR. ABO indicates the area of loss. At OQ, TC = TR. The point B, where TR intersects TC, is known as break-even point. Total Fixed Cost Break-even volume = or Price Variable cost Break-even volume = Fixed Cost Marginal Contribution per unit

28 Point B denotes break-even point.

29 Break-Even Analysis: - Assumptions a. Costs and revenue can be reliably determined and remain linear over the range. b. Costs can be classified as either fixed or variable. c. FC remains constant over the range. d. VC varies proportionately with volume. e. Selling prices do not differ. f. Prices of factors remain unaltered. g. Productivity & efficiency remain unchanged. h. Volume is the only factor affecting cost. i. Volume of sales and production are equal. j. Uniform Rupee value at production and sales points

30 Break-Even Analysis: - Limitations i. Linear relationship of costs do not hold good for all levels of output. ii. With increase in sales firm uses plant beyond capacity. iii. Addition of capacity or overtime increases costs sharply. iv. Product undergoes changes in quality. v. Depreciation estimates are quite arbitrary. vi. Matching time of output and cost is a serious limitation. vii. Selling price does not remain constant over the range of output.....contd.

31 Break-Even Analysis: - Limitations viii ix x And lastly xi Changes in the pattern of demand, product mix, concessions impair the accuracy of analysis. Analysis is static in nature. Assumes profit is the function of only output. Does not consider elements of uncertainty due to changes in tax structure.

32 Break-Even Analysis: - Uses a. BEA is useful toll of managerial planning and decision making. b. It is a simple and inexpensive device. c. It is useful as a frame of reference and vehicle for expressing the overall performance in situations where no other information is available. d. Useful to management as it provides information for decision making. Best of Luck!

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