COST OF PRODUCTION

In economics, the concept of production cost is determined in a wide meaning. It describes the
cost of production as the opportunity cost of all the economic resources that is forgone in the
production process. (The accountants estimates the cost of production only using the direct
cost)

Production cost is categorized in to two as short run cost and long run cost.

THE COST OF PRODUCTION IN THE SHORT RUN

There are two types of inputs as the variable inputs and the fixed inputs in the short run.
Therefore the cost of production also can be divided into two main categories as

1. Total fixed cost

2. Total variable cost

Total cost is estimated by adding both total fixed cost and total variable cost.

Total cost = total fixed cost + total variable cost

TC = TFC+TVC

Total cost = average cost x Number of units of inputs

TC= AC X Q

TOTAL FIXED COST

 Fixed costs are expenditure on fixed factors.

 Fixed costs are independent from output.
 Businesses have to bear a fixed cost even they do not produce any output. This cost
remains constant throughout the relevant range.
  Fixed costs often include rent, buildings, machinery, etc. there are some components
included in TFC. They are,

1. Amortization payment ( cost of long term assets over the life time of their use,
depreciation cost )
2. Property tax
3. License
4. Interest for the capital
5. Wages for managers and directors which are paid even though the production is in
progress or not.
6. Normal profit

CHARACTERISTICS OF THE TOTAL FIXED COST

1. FC exists even though the production is zero

2. If the production increase in the short run TFC remain unchanged
3. TFC curve is parallel to the horizontal axis

Q TFC
0 50
1 50
2 50
3 50
4 50
 TOTAL VARIABLE COST

Variable costs are costs that vary with output. Examples for variable cost are wages, utilities,
materials used in production, etc.

TVC = TC – TFC

TVC = AVC x Q

Characteristics

1. When the production is zero TVC too becomes zero

2. When the production increases TVC too increases. But the rate of increasing cost
changes with various production levels.

Q TFC TVC TC AFC AVC AC MC

0 50 0 50 œ - œ 49
1 50 49 99 50 49 99 31
2 50 80 130 25 40 65 19
3 50 99 149 16.7 33 49.7 13
4 50 112 162 12.5 28 40.3 13
5 50 125 175 10 25 35 19
6 50 144 194 8.3 24 32.3 31
7 50 175 225 7.1 25 32.1 49
8 50 224 274 6.2 28 34.2 74
9 50 296 348 5.6 33 38.6 102
10 50 400 450 5 40 45

DRAW THE TVC CURVE

 Output level

The shape of the total variable cost curve reflects increasing marginal returns at small
quantities of output and decreasing marginal returns at large quantities.

TOTAL COST

Total cost is the overall opportunity cost incurred by a firm in production. For short-run
production, total cost consists of variable cost and fixed cost. Variable cost changes with the
output and fixed cost does not change. Therefore total curve gets the same shape of the total
variable cost.

Tc = TFC + TVC

CHARACTERISTICS OF THE TOTAL COST

1. TC equals to the TFC where the output is zero

 2. TC increases When the output increase but TC increases slowly at the beginning and
then faster at the higher quantity due to the law of diminishing returns

Draw all 3 curves in one graph

TFC

TVS

OM of the diagram shows TFC. TC curve starts at that point. Gap between TC and TVC shows
TFC along the curves. TC curve is built by adding distances of TVC and TFC.