Cost-output Relationship
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Cost-output Relationship www.mbaknol.com
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Cost-output Relationship. Cost-output relationship has 2 aspects: Cost-output relationship in the short run, Cost-output relationship in the long run The SR is a period which doesn’t permit alterations in the fixed equipment (machinery , building etc) & in the size of the org. - PowerPoint PPT Presentation
Transcript of Cost-output Relationship
Cost-output Relationship
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Cost-output relationship has 2 aspects:
Cost-output relationship in the short run, Cost-output relationship in the long run
The SR is a period which doesn’t permit alterations in the fixed equipment (machinery , building etc) & in the size of the org.
The LR is a period in which there is sufficient time to alter the equipment (machinery, building, land etc.) & the size of the org. output can be increased without any limits being placed by the fixed factors of production www.mbaknol.com
Cost-output Relationship In The Short Run
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Short Run may be studied in terms of
Average Fixed Cost
Average Variable Cost
Average Total cost
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Total, average & Total, average & marginal costmarginal cost
1. Total cost (TC) = TFC + TVC, rise as output rises
2. Average cost (AC) = TC/output
3. Marginal cost (MC) = change in TC as a result
of changing output by one unit
Fixed cost & variable Fixed cost & variable costcost
1.Total fixed cost (TFC) = cost of using fixed factors = cost that does not change when output is changed, e.g.
2. Total variable cost (TVC) = cost of using variable factors = cost that changes when output is changed,
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Average Fixed Cost and Output
The greater the output, the lower the fixed cost per unit, i.e. the average fixed cost.
Total fixed costs remain the same & do not change with a change in output.
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Average Variable Cost and output
The avg. variable costs will first fall & then rise as more & more units are produced in a given plant.
Variable factors tend to produce somewhat more efficiently near a firm’s optimum output than at very low levels of output.
Greater output can be obtained but at much greater avg variable cost.
E.g. if more & more workers are appointed, it may ultimately lead to overcrowding & bad org. moreover, workers may have to be paid higher wages for overtime work.
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Average Total cost and output
Average total cost, also known as average costs, would decline first & then rise upwards.
Average cost consists of average fixed cost plus average variable cost.
Average fixed cost continues to fall with an increase in output while avg. variable cost first declines & then rises.
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So , as Avg. variable cost declines the Avg. total cost will also decline. But after a point the Avg. variable cost will rise.
When the rise in AVC is more than the drop in Avg. fixed cost that the Avg. total cost will show a rise.
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Cost-output Relationship In The Long-Run
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long run period enables the producers to change all the factor & he will be able to meet the demand by adjusting supply. Change in Fixed factors like building, machinery, managerial staff etc..
All factors become variable in the long run.
In the long run we have only 3 costs i.e. total cost, Average cost & Marginal Cost
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1. Total cost (TC) = TFC + TVC, rise as output rises
2. Average cost (AC) = TC/output
3. Marginal cost (MC) = change in TC as a result of changing output by one unit
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When all the short run situations are combined, it forms the long run industry.
During the SR, Demand is less & the plant’s capacity is limited. When demand rises, the capacity of the plant is expanded.
When SR avg. cost curves of all such situations are depicted, we can derive a long run cost curve out of that.
We can make a LR cost curve by joining the tangency points of all SR curves
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We use long run costs to decide scale issues, for example mergers.
In the long run, we can build any size factory we wish, based on anticipated demand, profits, and other considerations.
Once the plant is built, we move to the short run. Therefore, it is important to forecast the anticipated demand. Too small a factory and marginal costs will be high as the factory is stretched to over produce.
Conversely too large a factory results in large fixed costs (e.g.. air conditioning, or taxes) and low profitability.
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Thank You
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