# What happens when costs are higher than revenue?

## Application of the equations income, cost and utility examples

Contents

Skip to contentInstagram page opens in new windowYouTube page opens in new windowCAMPUS ONLINECONTACTARTEMEEM 13: Secondary Economics OpositionsAuthors: Belén Palomero and Sara Rodríguez Outline:1.- Introduction.2.- Short and long run production costs.2.1.- Types of terms.2.2.- Difference between short and long run cost functions2.3.- Analysis of average and marginal cost functions3.- Economies and diseconomies of scale.3. .1.- Concept3.2.- Causes of economies of scale3.3.- Causes of diseconomies of scale4.- Relationship between short and long run curves: the optimal size4.1.- Difference between short run and long run optimum4.2.- Implications on the optimal size5.- Conclusions6.

In the long run, all factors are already variable, fixed costs have been amortized and are considered sunk costs, so only variable costs are important in the analysis, and the total cost function could be of the form represented below (the traditional view) or of others, if technical progress or any other factor allowing to overcome diminishing returns were achieved.

### How to calculate the investment cost

In economics, profit maximization is the short-run or long-run process by which a firm can determine the price, input, and output levels that lead to the highest profit. Neoclassical economics, now the general approach to microeconomics, usually models the firm as profit maximizing.

There are several perspectives one can take on this problem. First, since profit equals revenue minus cost, one can graph each of the revenue and cost variables as functions of the level of output and find the level of output that maximizes the difference (or this can be done with a table of values rather than a graph). Second, if the specific functional forms are known for their revenue and cost in terms of output, the calculation can be used to maximize the profit with respect to the output level. Third, since the first order condition for optimization is equal to marginal revenue and marginal cost, if the marginal revenue and marginal cost functions in terms of output are directly available, one can match this, using equations or a graph.

### Income and expenses examples

To define an adequate price for your product or service, the first thing to do is to calculate the cost of sales. The price is key to compete and allows you to know the profit margin you can obtain.

Knowing the cost of sales also helps to define the Monthly Recurring Revenue (MRR). This is the revenue you receive each month. Many times they are subscription payments.

Many startups and established brands use MMR as their main source of revenue. And to make it stable, they put permanence conditions on subscriptions. Examples are companies like Netflix, online media, gyms, etc.

In the B2B sector, another strategy to build loyalty among recurring customers is to give a large initial discount. This allows you to beat the competition. And the cost to acquire the customer is offset by the expense they make in the long run. The key to making this strategy work is to qualify customers well with a high lifetime value.

### What is the difference between revenues and expenses called?

Fixed costs are those that do not vary with the volume of production. For example: rent of premises, depreciation and salaries. Variable costs, on the other hand, change when there is a variation in production volume.

The contribution margin is important because it makes it possible to determine how much a given product is contributing to the company, so that it is possible to identify to what extent it is profitable to continue with the production of that item.

Let’s look at an example. The manufacturer Antonio produces 1,000 pencils per month and sells them at S/ 10 each, so he records a sales volume of S/ 10,000 per month. Antonio has an employee who helps him with production and to whom he pays a salary of S/ 2,000. Raw material costs are S/ 5 per pencil; that is, S/ 5,000 per month. Thus, Antonio obtains a profit of S/ 3,000 euros.

If the contribution margin is positive, it allows absorbing the fixed cost and generating a margin for the expected profit. The higher the contribution margin, the higher the profit (the fixed cost is always fixed, even if the contribution margin varies).