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3.2 Firm Level Cost Concepts
3.2 Firm Level Cost Concepts
2
COST CONCEPTS
Cost concept is one of central area of behavioral analysis of the firm. Cost considerations
enter into almost every business decision. The kind of cost concept to be used in a
particular situation depends upon the type of economic or business decision to be made.
Thus, it is important to understand what these various cost concepts are, and how they are
useful in different economic as well as business decision. Major economic cost concepts are
as below
Marginal cost and average cost can differ greatly. For example, suppose it costs tk.1000 to
produce 100 units and tk.1111 to produce 101 units. The average cost per unit is tk.11,
but the marginal cost of the 101st unit is tk.111.
For better understanding of the above cost concepts the following mathematical and
graphhical examples can be taken to the task:.
Quantity Total Total Total Quantity Average Average Average Marginal
of Fixed Variable Cost of Fixed Variable Total Cost
Output Cost Cost Output Cost Cost Cost
0 30 0 30
1 30 20 50 1 30 20 50 20
2 30 30 60 2 15 15 30 10
3 30 45 75 3 10 15 25 15
4 30 80 110 4 7.5 20 27.5 35
5 30 145 175 5 6 29 35 65
The above cost table can be represented graphically as follows:
70
200
MC
180 TC
60
160
140 50
120
40
Cost
100 ATC
80 30
Cost
60
20 AVC
40
FC
20 10
0
0 2 4 6 0
0 1 2 3 4 5
Quantity
Quantity
The managerial economists’ approach to valuation is to take a look at the future revenues
and costs that will result from an asset and to discount that future cash flows to present. In
whether to sell an asset or not, it is necessary to compare the price offer for it with present
value of its net future returns rather than with acquisition cost net of depreciation.
Traditional accounting data ignore the imputed or implicit costs. Surely such cost are
relevant to decision making. For example, an investment project may prove to be worth
undertaking if the salary of owner entrepreneurs and the interest cost of equity capital are
ignored while the same may not be economically viable when such cost are added to
explicit costs. Accounting data on overhead costs do not always clearly indicate which of
these are fixed cost and which are variable ones. A clear distinction between fixed and
variable cost i s essential particularly for short-run decisions.
Because of all these limitations, accounting cost data is not directly useful for all managerial
decisions. They have to be supplemented by additional data and re-classified for specific
uses.