Basic concept of Cost
Cost
The sum of the price paid to the inputs like rent, interest, wages, and other by producer to produce goods and services is known as cost
1. Money cost
The value of payment made in terms of money to the inputs used in the production in the form of rent, wages, salaries, allowences, profit, interest and price of raw materials is known as money cost.
2. Real cost
Real cost is a sacrifice made by the producer while producing goods and services. For example, Discomfort, pain are some examples of real cost.
3. Accounting cost
Cost which are necessary for accounting purposes is known as accounting cost.
4. Explict cost
The monetary payment of cash expenditure which a firm makes to those inputs which are not owned by the firm itself are called explict cost.
5. Implict cost
Implict cost ia the contribution made by the producer and his/her family members but not paid to them in monetary terms.
6. Economic cost
Economic cost is the aggregate of explict cost and implict cost.
Economic cost = Explict cost + Implict cost
Short-Run cost
Short-run is a time interval, which is too short to change all factor of production. It means all factor of production are not variable in short-run. Some factors are fixed and some are variable. Cost incurred on both fixed and variable factor of production in the short-run is known as short run cost.
Fixed cost
The cost incurred on the fixed factor used in the process of production is known as fixed cost. In other words, fixed cost are those cost which in total do not change with any changes in output.
Variable cost
Variable cost is the cost incurred on the purchase of variable factors used in the production. In other words, variable cost are those cost which vary directly with production.
Total cost
The overall amount of cost incurred by the producer while producing various units of goods and services in given time period is called total cost.
i.e. TC = TVC + TVC
Marginal cost
Marginal cost is the additional cost on total added by the production of one more unit of output.
Marginal cost is defined as the change in total cost resulting from one unit change in the level of output produced.
Mathematically,
MCn = TCn – TCn-1
Average cost
Average cost is per unit cost of production. Average cost, at each level of output is calculated by dividing total cost by the corresponding level of output/production. Mathematically,
AC =
Short-Run Total cost
1. Total Fixed cost (TFC)
The total amount of cost incurred on the fixed factor in short-run in the production process is known as total fixed cost. The total fixed cost remains constant whatever be the level of output, i.e. zero or more.
2. Total Variable cost (TVC)
The total amount of cost incurred on the variable factors in short-run is known as total variable cost. TVC remains at zero at zero level of output and it increases with increase in output.
3. Total cost (TC)
Total cost is self-defining. It is the sum of total fixed cost and total variable cost at each level of output or production.
Therefore,
TC = TFC + TVC
Table
| Quantity |
TFC |
TVC |
TC |
| 0 |
10 |
0 |
10 |
| 1 |
10 |
10 |
20 |
| 2 |
10 |
18 |
28 |
| 3 |
10 |
24 |
34 |
| 4 |
10 |
28 |
38 |
| 5 |
10 |
34 |
44 |
| 6 |
10 |
42 |
52 |
| 7 |
10 |
52 |
62 |
Diagram
Nature
- TFC remains the same whatever the output level, so TFC curve will parallel to x-axis.
- TC and TVC always have inverse s-shape due to the apply of law of variable proportion.
- TVC and TC curves are parallel to each other because the gap between TVC and TC is TFC which remains constant.
1. Average Fixed cost
- Average fixed cost is the outcome of total fixed cost divided by the unit of a commodity.
- Average fixed cost is the per unit fixed cost of the output.
- Average fixed cost goes on decreasing with the increase in output level but it is always positive.
- Average fixed cost takes the shape of L.
Mathematically,
AFC =
2. Average Variable cost
- Average variable cost is the outcome of total variable cost divided by the level of output.
i.e. AVC =
- At first, AVC decreases then reaches at maximum point and starts to increase.
- It takes the shape of U.
3. Average cost
- Average cost is the outcome of total cost divided by the level of output.
i.e. AC = or AC = AFC + AVC
- AC is the summation of Average Fixed Cost and Average variable cost.
- Average cost is the per unit cost of the output.
- At first, AC decreases, then reaches at maximum point and starts to increase.
- It takes the shape of U.
Table
| Quantity |
TFC |
TVC |
AVC |
AFC |
AC |
| 1 |
15 |
25 |
25 |
20 |
45 |
| 2 |
15 |
40 |
20 |
10 |
30 |
| 3 |
15 |
45 |
15 |
6.67 |
21.67 |
| 4 |
15 |
56 |
14 |
5 |
19 |
| 5 |
15 |
75 |
15 |
4 |
19 |
| 6 |
15 |
120 |
20 |
3.33 |
23.33 |
| 7 |
15 |
175 |
25 |
2.85 |
27.85 |
In this above table it shows units, average variable cost, average fixed cost, average cost, total cost and total variable cost where TFC is constant while TVC is increasing at decreasing rate and then it is increasing in increaing rate and AVC is determined by the TVC and units and AFC is determined by the TFC and units and AC is the sum of AVC and AFC.
Diagram
In this table, x-axis represents units y-axis represents AVC, AFC and AC and AVC takes the shape of U while AFC is taking the shape of english letter L.
Reason behind U-shaped AC curve/SAC curve
In the short run production process law of variable proportion operates. According to this law, At first, TP increases at increasing rate while TP of a firm increases at increasing rate. Total cost of firm increases at decreasing rate in this situation per unit production (AC) declines. So, At first SAC curve slopes downward after the certain output level TP increases at the decreasing rate in this situation total cost of the firm increases at the increasing rate and per unit cost also increases by this reason SAC slopes upward and takes the shape of English letter U.
Marginal Cost (MC)
- Change in total cost due to one unit change in output level is known as marginal cost.
- Marginal cost is the additional cost on total cost added by the production of one more unit of output.
i.e. MC = TCn – TCn-1
Table
| Units |
TC |
MC |
| 1 |
50 |
50 |
| 2 |
70 |
20 |
| 3 |
80 |
10 |
| 4 |
85 |
5 |
| 5 |
95 |
10 |
| 6 |
115 |
20 |
| 7 |
145 |
30 |
The given above table shows the units, total cost (TC) and marginal cost (MC). Here, TC first increasing at increasing rate then it is increasing at decreasing rate and MC is the change in TC.
Diagram
In this table, x-axis measures the units and y-axis measures the marginal cost. Marginal cost always takes the shape of U.
Relation between AC and MC curve
- When AC is decreasing MC lies below the AC.
- When AC is increasing MC lies above the AC.
- MC cuts AC from minimum point of AC.
- The decreasing and increasing rate of MC is faster than AC
