COST ANALYSIS

 Meaning of cost

 Types

- Economic Costs
 Outlay cost – Actual financial expenditure.
 Opportunity cost, Pecuniary cost, Social (opportunity) cost
 Explicit cost– Direct contractual monetary payments
incurred through market transactions.
 Implicit cost – Opportunity cost of owners’ own assets.
 Production cost & Selling costs
 Real cost & money cost
 Incremental cost – Total additional expenditure associated
with the expansion of output.
 Short run costs & long run costs

- Accounting Costs
 Capital costs, Overhead costs (indirect), Direct costs, Period
costs
 Out-of-pocket cost & Book costs
 Replacement cost & Original / Historical cost
 Avoidable & Unavoidable cost
 Direct & Indirect cost ( Traceable / Assignable Cost and Non-
Traceable / non-assignable cost)
 Present Vs Future costs

- Engineering Costs
 Planning costs
 Execution costs
 Operation costs

 Short run costs

Fixed cost / Supplementary cost – Costs that are incurred on
fixed factor input. They remain fixed at any level of out put.
Variable cost / Prime cost – Cost incurred on the variable factor
inputs. They vary directly with the level of output.
Behavioural Costs
 Total cost
Total Fixed cost – TFC remains constant at all levels of output,
thus independent of output.
Total variable cost – TVC varies with the output, thus directly
dependent on output.
* TVC initially increases at a decreasing rate, but after a point it
increases at an increasing rate. ( Law of variable proportion)
 Total cost – TC varies in the same proportion as the TVC

Per unit cost

- Average cost
Average Fixed cost – Per unit fixed cost
* As the output increases the TFC gets spread over a larger
output and hence AFC goes on progressively declining.AFC
curve is rectangular hyperbola. It approaches both the axes
asymptotically I.e., it gets very close to both the axes but
never touches them.
* The product of AFC with the output for any given level of
output at that level always remains same.

Average variable cost – Per unit variable cost

* AVC declines initially, reaches its minimum and then
begins to rise sharply. AVC is slightly U shaped.

Average total cost – Per unit total cost

*If the output of the firm is increased, ATC decreases
initially up to a point, then remains constant for a while &
thereafter starts rising. AC assumes U shape. ( declining
phase, constant phase and rising phase)
Marginal cost – MC is the rate of change in the total cost when the
output is increased by one unit. (The cost of producing the last
unit)
- In short run MC is independent of FC & is directly related to the
VC. Mc
curve also assumes U shape.

 Relationship between marginal cost and average cost

- When AC is falling, MC is also falling and AC>MC i.e., When both

MC and AC are falling, MC curve lies below the AC curve
- At certain stage MC starts rising but AC continues to fall, AC is still
above the MC.
- When AC is minimum, MC=AC i.e., MC intersects AC at its lowest
point.
- When both Ac & MC are rising, MC>AC i.e., AC curve lies below
MC.

 Area underlying the unit costs

- The point on each average cost curve measures the average cost,
but the area underlying them denotes total cost as under.
- Area underlying AFC curve measures the total fixed cost.
 Long run costs
In the long run, all costs are variable cost. There is no
dichotomy of total cost into fixed and variable costs.
Long run average cost curve: It is an envelope of various
SACs.
-- Features
- It is a tangent curve
- It is an envelope curve
- It is a planning curve
- It is a minimum cost combination curve
- It assumes flatter U shape
Long run marginal cost curve : It is derived from the slope
of total cost curve at various points relating to the given
output each time. This curve also assumes flatter U shape.
 Relationship between LAC and LMC
Same as in the case of SAC and SMC