BUSINESS ECONOMICS
TOPICS
GOAL OF BUSINESSES
COSTS OF BUSINESSES
PRICES AND REVENUES
MARKET STRUCTURE
MARKET CHANGE
INTERNATIONAL MARKETS
TYPES OF BUSINESSES
SOLE PROPRIETORSHIP
PARTNERSHIP
CORPORATION
GOAL OF A BUSINESS
MAXIMIZE PROFIT
PROFIT = REVENUES – COSTS
PROFIT = PAYMENT TO
OWNERSHIP
PURSUIT OF PROFIT ALLOCATES
RESOURCES
COMPETITION KEEPS PROFIT IN
LINE (AVERAGE: 3%)
BUSINESS PLAN
WHAT TO PRODUCE
WHO BUYS AND WHY
WHO ARE COMPETITORS
STAFFING AND SUPPLIES
SALES AND REVENUES
COSTS
PROFITS
ALL OVER MULTIPLE YEARS
FIXED COSTS
COSTS WHICH DON’T VARY WITH
HOW MUCH IS PRODUCED AND
SOLD
ALSO CALLED “OVERHEAD”
SPACE AND EQUIPMENT
MUST PAY
VARIABLE COSTS
COSTS THAT DIRECTLY
INCREASE WITH PRODUCTION
AND SALES
WORKERS, ENERGY, RAW
MATERIALS
MIX OF FIXED AND VARIABLE COSTS CAN
BE DIFFERENT FOR DIFFERENT BUSINESSES
GYM: ALMOST ALL FIXED
COSTS FOR SPACE AND
EQUIPMENT
PERSONAL TRAINER:
ALMOST ALL VARIABLE COSTS
(TIME)
TOTAL COSTS
TOTAL COSTS = FIXED COSTS + VARIABLE COSTS
RAY’S PIZZERIA (MONTHLY SALES)
FIXED COSTS
VARIABLE COSTS
2000 PIES
$10,000
$8,000
4000 PIES
$10,000
$15,000
TOTAL COSTS
$18,000
$25,000
ONE IMPLICATION OF THE DIFFERENCE BETWEEN
FIXED AND VARIABLE COSTS – THE SHUTDOWN RULE
IF ALL VARIABLE COSTS, SHUTDOWN
WHENEVER REVENUES ARE LESS THAN
COSTS
BUT IF HAVE FIXED COSTS, EVEN IF
SHUTDOWN, STILL ARE RESPONSIBLE
FOR FIXED COSTS
IN THIS CASE, STAY OPEN AS LONG AS
REVENUES EXCEED VARIABLE COSTS –
HAVE $ LEFTOVER TO APPLY TO FIXED
COSTS
EXAMPLE OF THE SHUTDOWN RULE
RAY’S PIZZERIA (4000 PIES)
FIXED COSTS
$10,000
VARIABLE COSTS
$15,000
TOTAL COSTS
$25,000
IF REVENUES ARE $22,000, PAYS VARIABLE COSTS, AND HAS $7000
REMAINING TO APPLY TO FIXED COSTS; IN “RED” BY $3000
IF SHUTDOWN, STILL MUST PAY FIXED COSTS OF $10,000
IF REVENUES ARE UNDER $15,000 THEN DOES SHUTDOWN
MARGINAL COST
SIMPLY THE COST OF MAKING ONE
MORE UNIT
OR, IF MAKING SEVERAL MORE
UNITS, THE COST PER UNIT
EXAMPLE: RAY WANTS TO
ADVERTISE TO TRY TO SELL 500
MORE PIES PER MONTH.
MARGINAL COST IS THE
ADDITIONAL COST PER PIE
RAY’S PIZZERIA (4000 PIES)
FIXED COSTS
VARIABLE COSTS
TOTAL COSTS
$10,000
$15,000
$25,000
IF RAY IS ALREADY SELLING 4000 PIES AT A TOTAL COST OF
$25,000, WON’T THE MARGINAL COST OF EACH OF THE
NEXT 500 PIES BE $25,000/4000 = $6.25?
NO, IF RAY USES HIS EXISTING SPACE, THEN FIXED COSTS
DON’T CHANGE. ADDITIONAL COSTS ARE ONLY VARIABLE
COSTS AT $15,000/4000, OR $3.75 PER PIE
DEFINITIONS
AVERAGE COST: TOTAL COSTS/#UNITS,
where total costs include fixed plus
variable
MARGINAL COST: WHAT IT COSTS TO
PRODUCE ONE MORE UNIT
usually is variable cost per unit.
LABOR ISSUES
A BUSINESS WANTS IN A WORKFORCE:
* APPROPRIATE SKILLS FOR THE JOB
* MOTIVATION
* DEDICATION
* ADAPABILITY
* PRODUCTIVITY
* LOW TURNOVER
QUESTION: PAY A HIGHER-THAN-NEEDED
WAGE TO GET THESE – SAVE $ IN LONG-RUN?
OWNING VERSUS LEASING
ADVANTAGES OF OWNING
* TOTAL CONTROL
* LOCK-IN COSTS
* FOR REAL ESTATE, POSSIBILITY
OF VALUE-APPRECIATION
ADVANTAGES OF LEASING
* FLEXIBILITY
* NOT “LOCKED-IN” TO SPACE
* AVOID POSSIBLE DEPRECIATION
HANDLING OF OWNERSHIP COSTS
IF LEASE, LEASE PAYMENTS ARE PART OF
FIXED COSTS
IF BUYING AND BORROW FUNDS, LOAN
PAYMENTS ARE PART OF FIXED COSTS
HOWEVER, EVEN IF OWN PROPERTY
FREE OF ANY PAYMENTS, PAYMENTS
COULD HAVE EARNED BY LEASING
SHOULD BE PART OF FIXED COSTS
WHEN TO GO TO THE NEXT LEVEL?
TWO REASONS TO EXPAND A
BUSINESS:
1) BECOME MORE COST-EFFICIENT
PRODUCING MORE AT A LOWER
COST PER UNIT
2) SELLING MORE UNITS (MORE
VOLUME) AND THEREFORE
MAKING MORE PROFIT
RAY DOUBLES THE SIZE OF HIS PIZZERIA
PIES PER MONTH
4000
8000
FIXED COSTS
$10,000
$20,000
VARIABLE COSTS
$15,000
$25,000
TOTAL COSTS
$25,000
$45,000
AVERAGE TOTAL COST
$6.25
$5.63
REVENUE @$10/PIE $40,000
$80,000
PROFIT
$15,000
$35,000
IS BIGGER ALWAYS BETTER?
YES, IF HAVE ECONOMIES OF SCALE –
COSTS PER UNIT FALL AS INCREASE
PRODUCTION
NO IF HAVE DISECONOMICES OF
SCALE – COSTS PER UNIT RISE AS
INCREASE PRODUCTION
MANAGEMENT AND COORDINATING
COSTS SEEM TO BE THE INHIBITING
FACTORS FOR CONTINOUS
ECONOMIES OF SCALE