Blog Assignment #3

MARGINAL ANALYSIS

Any firm which is manufacturing and selling goods would require doing marginal analysis to ascertain various parameters pertaining to business. These parameters viz fixed cost, variable cost and marginal cost which helps us driving majorly revenue function, cost function and profit function. These in a way improve business decision making to run the business. These functions would also reflect firm’s performance and how it could handle competition from other firms by changing cost, price or business processes.

Fixed cost would include all the cost which are required to run the business, however are not directly related with the cost of producing goods. This includes the establishment cost, rent, housekeeping cost, management cost.

Variable costs are those cost which are directly used to manufacture goods. These primarily include raw material cost, labour cost, cost of fuel used, etc.

We need to ascertain all the cost under these two parameters. There are several costs which would seem to be both fixed and variable cost such as electricity. It could be used as direct input for manufacturing goods or also used otherwise which are not related to manufacturing.

Marginal cost is the variable cost which is required to produce one additional unit. So, we could derive our cost function from these costs as

Cost Function

Cost= Fixed cost + Variable cost per unit * No. of units produced

Revenue function

Revenue= Price per unit * Units sold

Profit function

Profit = Revenue – Cost

Break even sales volume is the units sold and thus, revenue generated is able to cover the fixed and variable cost. This is very crucial while running the business. We could take decision which would be in accordance with the demand, profit, competition, where to focus.

In the below picture, we can see if we sell units lesser than the break even sales volume, then we would incur loss and above breakeven sales volume, we would start making profits. In case of demand is lesser than our break-even required, we need to take decision which could surge demands through marketing, reduce variable cost and contain fixed cost or diversify business.

We would take example of a new Jumbo Firm which is planning to sell burgers. They would start their operation in 2016. Before launching they have gathered various data about the cost of operation in Connecticut city and market demand for the burger through market research. Findings of the research and extensive analysis gave the several key cost parameters. It would require monthly fixed cost of $15000 for starting the business and it takes $5 to make one piece of burger in Connecticut. They want to sell the burger initially at $10.

Using the above information, we can prepare table and plot graph with the following functions.

Fixed cost F= $15000   Variable cost V = $5       Total Cost C = 15000 + 5* Units sold Q     Selling price= $10

Revenue R = 10* Units sold Q                        Profit P= 10*Q - C

Fixed Cost	Variable cost per unit	Units Sold	Price	Revenue Generated	Total Cost	Profit
15000	5	30	10	300	15150	-14850
15000	5	300	10	3000	16500	-13500
15000	5	600	10	6000	18000	-12000
15000	5	900	10	9000	19500	-10500
15000	5	1200	10	12000	21000	-9000
15000	5	1500	10	15000	22500	-7500
15000	5	1800	10	18000	24000	-6000
15000	5	2100	10	21000	25500	-4500
15000	5	2400	10	24000	27000	-3000
15000	5	2700	10	27000	28500	-1500
15000	5	3000	10	30000	30000	0
15000	5	3300	10	33000	31500	1500
15000	5	3600	10	36000	33000	3000
15000	5	3900	10	39000	34500	4500
15000	5	4200	10	42000	36000	6000
15000	5	4500	10	45000	37500	7500
15000	5	4800	10	48000	39000	9000
15000	5	5100	10	51000	40500	10500
15000	5	5400	10	54000	42000	12000

We can ascertain Break even quantity as

Revenue R = Total cost C

Q* 10= 15000+ Q*5

Q= 15000/5

 Break even Quantity Q = 3000 units

From the above table and graph, it is quite apparent that Jumbo firm makes break even at 3000 units of burger sold per month. If it sells lesser burger than 3000, it would make loss and above 3000 units, it starts making profit. So, every day on average, it would require to sell 3000/30= 100 units of burgers.

Marginal cost is the increase in cost for one additional unit and Marginal revenue is the increase in revenue for one additional unit.

So, Marginal cost MC= $5 and Marginal Revenue MR=$10. For making profit or achieving break even, it is required that MR should be greater than MC. It is also evident from the graph that to reach breakeven, slope of revenue function should be greater than the slope of cost function.

As long as there is MR> MC, it would always be profitable to increase output by one extra quantity and increase in production quantity would decrease the average cost of production.