Cost of production are the payments made by the firms in the production process. Some of these can be classified as CoP

  • Wages and salaries paid to workers
  • Taxes paid to government based on what was produced
  • Purchase and maintenance of equipment

Types of Cost

Fixed Cost: These are costs that would paid during production process regardless of what would be produced. Major example would be purchasing equipment for production process, paying of rent, insurance premiums etc

Fixed cost

Variable Cost: these are cost that changes when the level of output changes. Examples are cost of raw materials, paying wages of labourers etc

variable cost

Total Cost: This refer to the sum of fixed cost and variable cost.

Average Fixed Cost (AFC): This is a cost per unit of good produced. As a firm produces more output, its fixed cost is divided by the quantity that has been fully produced.

It is calculated as AFC= Fixed Cost / Output

Average Fixed Cost

Average Variable Cost (AVC): This is the variable cost of production per unit of output. It is calculated by dividing variable cost by output produced.

AVC= variable Cost / Output

Average Total Cost (ATC): This is popularly known as cost per unit which refers to the total cost of making one product. This is the cost of a producing one product.

ATC= Total Cost / Output  

Average Total Cost

Revenue is the amount sold multiplied by the price per unit sold. Revenue from sales is known as turnover.

Total Revenue = Price per unit * quantity sold

Profit or Loss = Total revenue – Total cost.

If total revenue exceeds total cost a firm will make a profit. Profit is therefore maximized when the difference between total revenue and total cos is the greatest. However, if the total revenue does not cover the total cost, a firm will make a loss and if it continues the business will go out of business.

Break Even level of output is that level of output which if sold total revenue will equal total break-even point a firm will neither make a profit or a loss.

The break-even level of output can be found graphically where the total revenue line crosses the total cost curve. At break-even point a firm is able to cover all its cost and can remain in business for certain number of years.

Break Even Point

It can also be calculated as

Break even level of output = Total Fixed Cost / (Price per Unit – Variable per unit)

Objectives of Firm

Objectives are the goal or targets of an organisation. These goals motivate the business to continually produce goods and services. These objectives are:

  1. Profit Maximization: A firm earns profit if its total revenue exceeds its total cost of production. this is an incentive for entrepreneurs to take risks. Profit can be said to be a measure of success and financial stability as it can be used to secure bank loans or attract new investors. Profits can also be reinvested into the business in order to expand the scale of production.
  2. Growth: This involves increasing the size of business. it is aimed at increasing the revenue and market share of the organisation. An increase in sales revenue can ensure lower average cost due to economies of scale, it can also give the firm the ability to diversify into different products and markets to reduce market risks.
  3. Survival: While starting and running a business can be a bit difficult, surviving in the market is the most important. New technology can change production processes and product design and if attention is not paid to it can lead to the demise of the firm. During recession, large firms maybe forced to close down as a result of falling demand and increase in unemployment if they don’t reassess their chances of survival.
  4. Social Welfare and Environmental Objectives: Social firms are firms who organize resources and activities to help address social and environmental issues rather than maximizing profit. They will usually reinvest any profit or surplus revenue their activities make into their firms to attain their socio-welfare and environmental goals. Socially responsible business strive to improve the treatment of workers, customers or shareholders and the natural environment such as charities aim to provide services to enhance the welfare of others in the society.