3.

2 ANALYSIS OF COST

Cost- It is the payment made to the factors of production which are used in the
production of the commodity.

Cost of Production-The money value of inputs is called as the cost of production.

Cost Function- The cost function is a derived function. it depends upon production
function. It can be expressed as C =f (Q)

Types of Cost:-

1. Money Cost- Also known as accounting cost. It is defined as all the expenses
incurred by a firm to produce a commodity. These are normally entered in the records
of accounts of an organisation.

2. Real Cost- Defined as all those efforts and sacrifices undergone by various
members of the society to produce a commodity.

3. Explicit Cost- Actual payment made for the purchase of factors of production for
the production of the commodity. (cost outside)

Ex- The payment on account of wages, salaries, interest, rent, purchase of raw
materials, license fees, insurance premium and depreciation charges.

4. Implicit Cost- Costs which do not take the form of cash outlays (i.e. the imputed
value of inputs owned and used by the firm in its own production unit) , nor they
appear in the accounting system. (cost within)

5. Opportunity Cost- Also known as alternative / transfer cost. It is the next best
alternative that is foregone or sacrificed. According to Benham " the opportunity cost
of anything is the next best alternative that could be produced instead by the same
factors or by an equivalent group of factors, costing the same amount of money". It
arise because of scarcity and alternative uses of resources.

6. Economic Cost= Explicit+ Implicit cost

7. Fixed Cost- Also known as overhead or supplementary costs These costs are
incurred as a result of the use of fixed factor inputs. They remain fixed at any level of
output in the short-run.

8. Variable Cost- Also known as prime cost. Costs that are incurred by the firm as a
result of the use of variable factor inputs. They are dependent upon the level of
output.

Ex- Prices of raw materials, wages of labour, fuel and power charges, excise duties,
transport expenditure etc.
A. Short-run Costs and Cost Curves:

i) Total Cost (TC) - It is the sum of all expenditures incurred by the firm in producing
a given volume of output. TC = f (Q)

The total cost further split into:

a. Total Fixed Costs (TFC)- The expenditure incurred on the purchase of fixed inputs.
It remains the same at all levels of output in the short-run.

b. Total Variable Costs (TVC)- These are the costs incurred on the purchase of
variable inputs. The change when output is changed.

Thus, TC = TFC+ TVC

Example- Output TFC TVC TC

0 60 0 60

1 60 100 160

2 60 180 240

3 60 240 300

4 60 340 400

5 60 500 560

6 60 720 780
ii) . Average Fixed Cost- Per unit cost of producing a given level of output. It is
𝑇𝐹𝐶
obtained by dividing total fixed cost by the quantity of output . AFC=
𝑄

iii) Average Variable Cost- It is obtained by dividing the total variable cost by the
𝑇𝑉𝐶
quantity of output. AVC=
𝑄

iv) Average Cost- It is obtained by dividing the total cost of production with total
𝑇𝐶
numbers of units produce. AC= ( AC= AFC+AVC)
𝑄

v) Marginal Cost- It is the addition made to the total cost by the production of an
additional unit of the commodity.
Δ𝑇𝐶
MC= TCn-TCn-1 or
Δ𝑄

Output TFC TVC TC AFC AVC AC MC

0 100 0 100 ∞ - - -
1 100 90 190 100 90 190 90
2 100 170 270 50 85 135 80
3 100 240 340 33.3 80 113.3 70
4 100 300 400 25 75 100 60
5 100 370 470 20 74 94 70
6 100 450 550 16.67 75 91.67 80
7 100 540 640 14.29 77.14 9143 90
8 100 650 750 12.50 81.25 93.75 110
9 100 780 880 11.11 86.67 97.78 130
10 100 930 1030 10 93 103 150
Relationship between AC and MC :

Output TC AC MC
1 30 30 30
2 50 25 20
3 60 20 10
4 72 18 12
5 85 17 13
6 102 17 17
7 126 18 24
8 160 20 34