Cost
Transcript of Cost
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Cost: A Definition
In order to produce a good, every firm makes use of various factor and non-factor inputs. In common parlance the amount spent on these inputs is called cost of production.Cost function: A firm’s cost function is the functional relationship between its cost and its output.
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Theories of Cost
Traditional Theory
Modern Theory
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Traditional Theory VS Modern TheoryMain Difference between traditional and modern theories of cost is that the traditional economists believe that average and marginal cost curves are ‘U’ shaped while the modern economists believe them to be of ‘L’ shaped.
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Traditional Approach
Short Run Cost Curves
Long Run Cost Curves
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Short Run Cost
Total Cost Average Cost Marginal Cost
Total Fixed Cost
Total Variable Cost
Average Fixed Cost
Average Variable Cost
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Total Cost (TC)
Total cost is the sum of all those expenses that the producer incurs in order to produce a given quantity of a commodity. In the words of Browing, “ Total cost identifies the costs of all the inputs, fixed and variable, used to produce a certain output. TC= TFC + TVC TFC= Total Fixed CostTVC= Total Variable Cost
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Total Fixed Cost (TFC)In short period, the costs of fixed inputs are called total fixed costs. The fixed cost is equal to the unit of fixed factors multiplied by its price. TFC remains constant at all the levels of output ranging from 0 to infinity.
Cost
Output
TFC
0
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Total Variable Cost (TVC)
Variable costs are those costs which are incurred on the use of variable factors of production. These costs vary with the change in output level.In the words of Ferguson’ “Total variable cost is the sum of amounts spent for each of the variable input.”
CostTVC
Output0
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As described earlier TC is the sum of TFC and TVC…TC = TFC + TVC
Cost
TC
0 Output
TFC
TVC
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Average Cost (AC)
Average cost is the cost per unit of output. It is also called unit cost of production. It is obtained by dividing the TC by the level of output.
AC = AFC + AVCAFC= average fixed costAVC = average variable cost
output. of level theis Q where
Q
TCAC
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Average Fixed Cost (AFC)
Average fixed cost is per unit fixed cost. It is total fixed cost divided by output.
AFC curves continuously declines but never touches X axis.
Q
TFCAFC
AFC
Output0
Cost
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Average Variable Cost (AVC)
Average variable cost is per unit variable cost. It is total variable cost divided by output.
Q
TVCAVC
Cost
0 Output
AVC
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As described earlier … AC = AFC + AVC
Cost
0 Output
AC
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Marginal Cost (MC)
Marginal cost is the increase in total cost when output is increased by on unit. It is cost of producing one extra unit.
1
nn TCTC
Q
TCMC
Cost
0Output
MC
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Cost
Output0
AFC
AVC
AC
MC
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Output TC TFC TVC AFC AVC AC MC
0 10 10 0 -- 0 -- --
1 20 10 10 10 10 20 10
2 28 10 18 5 9 14 8
3 34 10 24 3.3 8 11.3 6
4 38 10 28 2.5 7 9.5 4
5 42 10 32 2.0 6.4 8.4 4
6 48 10 38 1.7 6.3 8 6
7 56 10 46 1.4 6.6 8 8
8 72 10 62 1.2 7.8 9 16
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Long Run Cost
The long run is the period of time in which all inputs are variable. The firm has sufficient time to adjust its use of all inputs to produce output in the least costly way. In other way the firm can plan to produce at the minimum cost. The long run refers to the fact that producers can plan ahead and choose from among different methods of production of the short run to produce in future. Thus in a sense, the long run consists of all possible short run situations among which a
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Producer may choose. In other words, the producer operates in the short run and plans in the long run.
Long Run Cost Curves
Total Cost Marginal CostAverage Cost
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Long Run Total Cost (LRTC)The long run total cost of production is the least possible cost of producing any given level of output when all inputs are variable.LRTC is always less than or equal to short run total cost, but it can never be more than short run total cost.
STCLTC
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Long Run Average Cost (LAC)
Long run average cost refers to minimum possible per unit cost of producing different quantities of output in the long run. In the words of Mansfield, “The long run average cost curve is that curve which shows the minimum cost per unit of producing each output level, corresponding to different scales of productivity.
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Long Run Marginal Cost (LMC)Change in the total cost, in the long run, due to production of one-more or one less unit of a commodity, is called long run marginal cost.
cost
Output
LMC
0