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 Explicit Costs: input costs that require a direct

outlay of money by the firm for use of resources
owned by others. Normally recorded in the firm’s
income statement.
 Implicit Costs: Opportunity costs of using self-
owned resources. Money payments that self-
employed resources could have earned in their
best alternative use.
 Sunk Costs: costs that cannot be avoided even by
going out of business. They are irrecoverably lost
and should not affect current decisions. Refer to
outlays that have already occured at the time of
decision making. E.g. market research costs
before launch of new product.
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 Fixed Costs (FC): do not vary with the level

of output. FCs have to be paid even if AFC  FC AVC  VC
output is zero. E.g. rent, insurance. Q Q
 Variable Costs (VC): vary directly with the
quantity of output produced. E.g. wages,
fuels, raw materials. TC  FC  VC
 Total Cost (TC): sum of FC and VC at each
level of output. At zero units of output

MC  TC
TC=FC.
 Marginal Cost (MC): increase in TC that AC  TC Q
arises from producing one more unit of Q
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Costs TC

TVC
Output TFC AFC TVC AVC TC AC MC
0 12 - 0 - 12 - 10
1 12 12 10 10 22 22 6
2 12 6 16 8 28 14 5
3 12 4 21 7 33 11
7
4 12 3 28 7 40 10
12
5 12 2.4 40 8 52 10.4
6 12 2 60 10 72 12 20
7 12 1.7 91 13 103 14.7 31

TFC

Output
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 The shape of the MC curve follows the

Cost
ATC law of diminishing marginal returns.
per MC
Unit  Beyond a certain level of output (x)
AVC additional units of output cost more and
more to produce since they require ever
increasing amounts of the variable
factor.
 AFC fall continuously since fixed costs
are being spread over a greater and
AFC
greater output.
Q
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 ATC & AVC curves are U-shaped Cost

per
ATC

because of the law of diminishing Unit

returns.
 When MC is below ATC, ATC is falling.
 When MC=ATC, ATC is at its 2500 Q
minimum.
• SR cost curves are drawn for a given quantity of
 MC cuts both AVC and ATC at their the fixed factor.
minimum. •Output that corresponds to the minimum of ATC
 When MC is above ATC, ATC is rising. is called total capacity of full capacity (capacity at
least cost).
 Similar r/ship between MC & AVC.
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 A firm may choose to alter its scale of

Cost LRAC
operations if prospects of success are per
high. unit B
 For some time, successively larger plants A
D
will lower average costs.
A time will eventually come when
expansion will result in increasing average
Q
costs.
 To move from one point on the LRAC curve to
 The long run average cost curve is thus the
another requires an adjustment of all factors which
locus of all minimum points of the may require building a larger plant.
unlimited number of SRATCs.
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1. Economies of Scale: LRAC declines as output

increases. EOS arise due to labour
Economies Diseconomies specialisation, managerial specialisation and
Cost of of use of efficient capital.
per Scale Scale LRAC
Unit Constant
2. Constant Costs: the minimum efficient scale
Returns to (MES) is the smallest level of output at which
Scale
LRAC reaches its minimum. Average costs
remain unchanged as output increases.
Decreasing Increasing
3. Diseconomies of Scale: LRAC rises as output
Costs Constant Costs increases. These can arise due to coordination
Costs
problems. An expanded management hierarchy
Q m
Q leads to communication challenges (red tape).
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