CONCEPT OF COST

PRESENTED BY RAHUL LADUNA

MEANING OF COST COST OF PRODUCING A GOOD IS THE

SUM OF ACTUAL MONEY EXPENDITURE ON PURCHASE OF INPUTS AND

ESTIMATED EXPENDITURE ON INPUTS SUPPLIED BY THE FIRM ITSELF.

COST = EXPLICIT COST + IMPLICIT COST

EXPLICIT COST AND IMPLICIT COSTEXPLICIT COST – THE ACTUAL MONEY SPENT

BY A FIRM ON BUYING OR HIRING OF FACTORS OF INPUTS AND NON-FACTOR

INPUTS IS CALLED MONEY COST OR EXPLICIT COST.

IMPLICIT COST – IT IS THE ESTIMATED VALUE OF INPUTS SUPPLIED BY THE OWNER OF THE

FIRM HIMSELF.

COST FUNCTION THE FUNCTIONAL RELATIONSHIP BETWEEN OUTPUT AND COST IS CALLED COST FUNCTION.

C = WHERE C = COST

F = FUNCTION Q = UNITS OF OUTPUT

IN SHORT, COST FUNCTION STUDIES THE RELATIONSHIP BETWEEN THE COST OF INPUTS AND LEVEL OF OUTPUT.

SHORT RUN COSTS

•1. TOTAL COST (TC)REFERS TO THE TOTAL EXPENDITURE INCURRED BY A FIRM ON THE FACTOR OF PRODUCTION REQUIRED FOR THE PRODUCTION OF COMMODITY.

•2. TOTAL FIXED COST (TFC) REFERS TO THOSE COST WHICH DO NOT VARY DIRECTLY WITH THE LEVEL OF OUTPUT.

•3. TOTAL VARIABLE COST (TVC)REFERS TO THOSE COST WHICH VARY DIRECTLY WITH THE LEVEL OF OUTPUT.

SHORT RUN COSTS 1. TOTAL COST (TC)

TC = TFC + TVC2. TOTAL FIXED COST (TFC)

TFC = TC - TVC3. TOTAL VARIABLE COST (TVC)

TVC = TC - TFC

DISTINGUISH BETWEEN FIXED COSTS AND VARIABLE COSTS

FIXED COSTS (FC)• 1. FC DO NOT INCREASE OR DECREASE

WITH INCREASE OR DECREASE IN LEVEL OF OUTPUT.• 2. FC ARE COSTS OF FIXED FACTORS WHICH

CANNOT BE CHANGED DURING SHORT PERIOD.• 3. FC CAN NEVER BE ZERO EVEN WHEN

PRODUCTION IS STOPPED.• 4. PRODUCTION MAY CONTINUE EVEN AT

THE LOSS OF FC DURING SHORT PERIOD.• 5. FC CURVE IS PARALLEL TO X-AXIS.

VARIABLE COSTS (VC)

• 1. VC CHANGE WITH CHANGES IN THE LEVEL OF OUTPUT.• 2. VC ARE COSTS OF VARIABLE FACTORS

CAPABLE OF BEING CHANGED DURING SHORT PERIOD.• 3. VC IS ZERO WHEN PRODUCTION IS

STOPPED.• 4. A FIRM CONTINUES PRODUCTION ONLY

WHEN VC ARE MET.• 5. VC CURVE MOVES UP FROM LEFT TO THE

RIGHT.

•1. AVERAGE COST (AC)/AVERAGE TOTAL COST (ATC)

REFERS TO PER UNIT TOTAL COST OF PRODUCTION. AC = TC/Q

•2. AVERAGE FIXED COST (AFC) REFERS TO PER UNIT OF FIXED COST OF OUTPUT.AFC = TFC/Q

•3. AVERAGE VARIABLE COST (AVC)REFERS TO PER UNIT VARIABLE COST OF PRODUCTION.AVC = TVC/Q

MARGINAL COSTIT REFERS TO ADDITIONAL

TO TOTAL COST WHEN ONE MORE UNIT OF

OUTPUT IS PRODUCED.MC= MCN = TCN – TCN-1

MCN = TVCN – TVCN-1

Relation ship between….

Output TFC TVC TC AFC AVC AC MC0 100 0 100 - - - -1 100 50 150 100 50 150 502 100 70 170 50 35 85 203 100 80 180 33.34 26.67 60 104 100 105 205 25 26.25 51.25 255 100 135 235 20 27 47 306 100 170 270 16.67 28.34 45 35

Cost schedule

All costs are variable in the long run. There is only AVC in LR, since all factors are variable.

Long Run Cost Curve

Economies of Scale:Economies of scale are the cost advantages that a firm obtains due to expansion. Diseconomies is the opposite.Two types:1. Pecuniary Economies of Scale: Paying low prices because of buying in large Quantity.2.Real Economies of Scale: Refers to reduction in physical quantities of input , per unit of output when the size of the firm increases, as a result input cost minimized.

1.Internal Economies: It is a condition which brings about a decrease in

LRAC of the firm because of changes happening within the firm.

2.External Economies: It is a condition which brings about a decrease in LRAC

of the firm because of changes happening outside the firm.E.g. Taxation policies of government

Diseconomies: