Engineering Economics( Theory of Cost)

8/12/2019 Engineering Economics( Theory of Cost)

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Topic Name

"Theory of cost"


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Group members name

Muhammad Ijaz (Leader)

ID:( 091420-181)

Muhammad Qasim

ID:(101620039)Muhammad Ibrahim

ID:(101620027)

Ahmad Mehmood

ID:(091420-101)

Muhammad Waleed Sehgal

ID:(091420-041)

Muhammad Awais Amjad

ID:(091420-148)


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Content of Theory of cost Abstract Introduction Cost theory Body contents

Cost concept Short run and Long run in economics

Average and Marginal Cost Relationship Law of Diminishing return Equilibrium of Firm

Conclusion Reference


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Abstracts

Cost theory and production related to each other these terms are often usedtogether. However, the question is usually how much to produce, as opposed towhich inputs to use. That is, assume that we use production theory to choose theoptimal ratio of inputs how much should we produce in order to minimize costsand maximize prots? We can also learn a lot about what kinds of costs matter fordecisions made by managers, and what kinds of costs do not.

Introduction

Cost function are derived function they are derived from the production function, which describethe available efficient methods of production at any time. Economic theory distinguish betweenshort run and long run cost. short run cost are the cost over a period during which some factor of

production are fined the long run costs are the cost over a period long enough to permit thechange of all factors of production. In the long run all factor become variable.

Discuss how a firm will determine its profit-maximizing combination of output by minimizingcosts for this given level of output. Firm objective is to maximize profit for a given productiontechnology. Firms that do not do so are driven out of market by competitive forces. Objective ofa profit-maximizing firm is consistent with maximizing utility of firm owners under threeassumptions , Prices are fixed, Profits are no stochastic, Firm managers can be controlled byowners. determine profit-maximizing equilibrium, will first consider how to produce a givenlevel of output at least possible cost

the internal economics of scale relate only to the long run and are built into the shape of the long

run cost curve the internal economics effect the prices of the factor are production or the production function. The traditional theory of cost is U shaped some recent development in thetheory of cost which reject the U shaped.


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Cost theory:

Two types of costs associated with production Fixed Cost and Variable Cost. In the short-run, at least onefactor of production is fixed, so firms face both fixed and variable cost. The shape of the cost curves inthe short run reflect the law of diminishing returns.

Cost concept:

Actual Costs are the total money incurred by a firm in producing a commodity or service. e.g. wages and salaries, cost of raw materials, expenses on machines or capital goods, power charges,transportation, advertisement, interest expenses, taxes, etc

Implicit costs

Refers to the value of the inputs that are owned and used by the firm in its own productionactivity. These includes the highest salary that the entrepreneur could earn in his best alternativeemployment and the highest return that the firm could receive from investing its capital in themost rewarding alternative use or renting its land and buildings to the highest bidder.

Explicit cost

Are actual expenditures of the firm to hire, rent, or purchase the inputs it requires in production. These includes the wages to hire labor, the rental price of capital, and the purchase priceof raw materials and semi finished products.

Variable costs

Are costs that vary with the volume of output or Variable costs change in direct proportion to theactivity of a business such as sales or production volume.

Fixed costs

Fixed cost does not change with the volume of production. Or it do not vary with output in theshort-run.

Opportunity cost

Is the cost of missed opportunity or alternative forgone in having one thing rather than the other. Measurement of opportunity cost is difficult.
http://www.intelligenteconomist.com/theory-of-production-short-run-analysis/http://www.intelligenteconomist.com/theory-of-production-short-run-analysis/


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Marginal cost

Is the addition to the total cost by producing an additional unit of output. e.g.

MC = change in TC/change in TO

Short run and Long run in economics:

Short-run is defined as a time period during which some factors of production are fixed andothers are variable.

In the Long-run all factors of production are variable. It is important to note that these periods

are not defined by any specified length of time but instead are determined by the variability offactors of production.

Short run cost function:

Average total cost is the average per- unit cost of using all of the firms inputs (TC/Q)

Average variable cost is the average per- unit cost of using the firms variable inputs (TVC/Q)

Average fixed cost is the average per- unit cost of using the firms fixed inputs (TFC/Q)

Average Total Cost = ATC = TC/Q

Average Fixed Cost = AFC = TFC/Q

Average Variable Cost = AVC = TVC/Q

ATC = AFC + AVC

Q TFC TVC TC AFC AVC ATC MC0 $60 $0 $60 - - - -1 60 20 80 $60 $20 $80 $202 60 30 90 30 15 45 103 60 45 105 20 15 35 154 60 80 140 15 20 35 355 60 135 195 12 27 39 55


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Marginal Cost = TC/ Q = TVC/ Q

Long-Run Cost Curves

The long run period is a series of short run periods . The long run is the period of time during which:

o Technology is constanto All inputs and costs are variableo The firm faces no fixed inputs or costs

Long-Run Total Cost = LTC = f(Q)

Long-Run Average Cost = LAC = LTC/Q


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Average and Marginal Cost curve:

Law of Diminishing return:

According to law of economics as the number of new employees increases, the marginal product of an additional employee will at some point be less than the marginal product of the

previous employee.


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Diminishing return

Law of Diminishing return Graph:

-10

0

10

20

30

40

5060

70

0 2 4 6 8 10

Total Pdt

Avge Pdt

Marginal Pdt


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Equilibrium of Firm:

Firms will produce in such a way that the profit is maximized. Firms will not change the production

function at equilibrium output. When we going to increase labor there will be come a point where production going to decrease from each previous unit by increasing more labor and then tend to negative.So the entrepreneur try to get maximum benefit against expenditure spend on the labor.

Profit = TR-TC TR = P x Q (price x quantity) AR = TR/Q = (P x Q)/Q = P

Reference

https://www.google.com.pk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&sqi=2&ved=0CC4QFjAB&url=http

%3A%2F%2Fpersonal.lse.ac.uk%2Fsternn%2F040NHS.pdf&ei=MOWBU_mLNcLB7Ab76IA4&usg=AFQjCNESXedjn6TKEdBdSQYRgJYdmbzwdg&sig2=Cd4yH1dPAj3VRo4PrToxxA&bvm=bv.67720277,d.ZWU

http://www.investopedia.com/university/economics/economics7.as p

https://www.google.com.pk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=3&cad=rja&uact=8&sqi=2&ved=0CDkQFjAC&url=http%3A%2F%2Fwww.aeaweb.org%2Faer%2Ftop20%2F48.3.261-297.pdf&ei=MOWBU_mLNcLB7Ab76IA4&usg=AFQjCNG8C59KZdwvcCm52uu1H9SO3RMa3w&sig2=CtgRjuwqj35mmD90YS

NnTQ&bvm=bv.67720277,d.ZWU http://www.slideshare.net/jesuslovesu/theory-of-cost


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http://en.wikipedia.org/wiki/Diminishing_returns http://www.intelligenteconomist.com/theory-of-production-short-

run-analysis/

http://www.intelligenteconomist.com/theory-of-production-cost-theory/

Engineering Economics( Theory of Cost)

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