Cost and revenue curves

Cost function, concept of cost,

Short run cost and long run cost, derivation of short run
total, marginal, average cost and their relationship.
Reason for U shape cost curve and relation of AC and MC.
Economies scale,
Revenue, revenue function.
Revenue curve perfect and under perfect competition market.
Relationship between AR and MR, price elasticity of
demand and revenue.
 Cost function:- cost function shows the relationship between
inputs and outputs. The cost function expressed as
C= f(Q, Pf, T……)
Where, c= total cost
Q= total output
Pf= price of all factors
T= technology
Generally cost function is expressed as C=f(Q)

 Concept of cost:- generally, cost is total amount paid by

producer for producing goods and services. In other words
cost is define as the money expenditure incurred on factors of
production while producing goods and services.
 Various concept of cost
Explicit and Implicit costs:
 Explicit costs are those expenses that involve cash payments.
These are the actual or business costs that appear in the
books of accounts. These costs include payment of wages and
salaries, payment for raw-materials, interest on borrowed
capital funds, rent on hired land, Taxes paid etc.
Implicit costs are the costs of the factor units that are owned by
the employer himself. The two normal implicit costs are
depreciation, interest on capital etc. A decision maker must
consider implicit costs too to find out appropriate profitability
of alternatives.
Accounting and Economics costs:
Accounting costs are those for which the entrepreneur pays
direct cash for procuring resources for production. These
include costs of the price paid for raw materials and
machines, wages paid to workers, electricity charges, the
cost incurred in hiring or purchasing a building or plot, etc.
Accounting costs are treated as expenses. Which are
recorded in account book.
There are certain costs that accounting costs disregard. These
include money which the entrepreneur forgoes but would
have earned had he invested his time, efforts and
investments in other ventures. It is sum of explicit cost and
implicit cost.
Historical and Replacement costs:
 Historical cost is the original cost of an asset. Historical cost
valuation shows the cost of an asset as the original price paid for
the asset acquired in the past. Historical valuation is the basis
for financial accounts.
A replacement cost is the price that would have to be paid currently
to replace the same asset. During periods of substantial change in
the price level, historical valuation gives a poor projection of the
future cost intended for managerial decision. A replacement cost
is a relevant cost concept when financial statements have to be
adjusted for inflation.
Separable and common cost:-

Separable cost is defined as the cost that can easily known to a

product, a division or process. Or the cost easily separable
according to the different work, subject, department etc.

Common cost is defined as the cost that can’t be known to any unit
of operation. Other words, the cost can’t separable, it is joint cost
for any sector.
Opportunity cost:- opportunity cost refers to what an input could

earn in its next best alternative job. It arises due to scarcity and
alternative uses of resources.
 Short run cost
 Short Run Cost refers to a certain period of time where at
least one input is fixed while others are variable. In the
short-run period, an organization, land, cannot change the
fixed factors of production, such as capital, factory
buildings, plant and equipment, etc. However, the variable
costs, such as raw material, employee wages, etc., change
with the level of output. Finally, the short run costs are
those costs, which are incurred by the firm during a period
in which some variable factors.
Derivation of short run cost curves
Total variable cost(TVC) :-
It defined as the total expenses incurred on variable factor of
production. These costs are directly proportional to the output of a
firm. This implies that when the output increases, TVC also increases
and when the output decreases, TVC decreases as well. It can be
cleared by following table and diagram.
Unit of output TVC
0 0
1 20
2 30
3 45
4 80
5 145
 Total fixed cost (TFC):-
It is defined as the total expenses incurred by fixed factor
of production. These costs do not change with the change
in output. TFC remains constant even when the output is
zero. TFC is represented by a straight line horizontal to the
x-axis (output). It can be cleared by following table and
diagram.
Unit of output TFC
0 30
1 30
2 30
3 30
4 30
5 30
Total cost (TC):-
The total cost refers to the actual cost that is incurred
by an organization to produce a given level of output.
The Short-Run Total Cost (SRTC) is also called the sum
of TFC and TVC.
TC=TFC+TVC
Unit of output TFC TVC TC
0 30 0 30

1 30 20 50

2 30 30 60

3 30 45 75

4 30 80 110

5 30 245 175
 Short run average cost (SAC)
Average fixed cost (AFC):
AFC refers to the fixed cost spend per unit of output
produced. It is obtained by dividing total fixed cost by
total quantity of output produced.
AFC = TFC / Q
where,
AFC = average fixed cost
TFC = total fixed cost
Q = total quantity of output produced
It can be cleared by following table and diagram.
Average variable cost (AVC):
AVC refers to the variable cost spend per unit of output
produced. It is obtained by dividing total variable cost by
total quantity of output produced.
AVC = TVC / Q
where,
AVC = average variable cost
TVC = total variable cost
Q = quantity of output produced
It can be cleared by following table and diagram.
Average total cost (ATC):
It refers to the total cost spend per unit output produced. It is obtained by
dividing total cost (TC) by quantity.
ATC = TC / Q
=TFC+TVC/Q =
=TFC/Q + TVC/Q
=AFC+AVC
Where, ATC= average total cost
TFC= total fixed cost
AFC = average fixed cost
AVC= average variable cost
TC= Total cost
Q= output
Marginal Cost (MC):
It refers to the change in total cost due to change in
additional unit of output produced. Or marginal cost
is the ratio of change in total cost and the change in
total output. Symbolically it can expressed as,
MC = ∆TC / ∆Q
where,
MC = marginal cost
∆TC = change in total cost
∆Q = change in quantity of output produced
The relationship between AC and MC
AC and MC have closed relationship between to each
other. AC is per unit cost of production. It is derived
from total cost divided by output where as MC is the
change in total cost due to the change in one
additional unit of production. So, both AC and MC are
TC resulted. It means both are derived from TC.
AC= TC/Q
MC=dTC/dQ
 Both AC and MC are derived from TC
 Bothe are U shaped.
 When AC is falling MC also falling but the slope of MC
is more than AC.
 When AC is minimum MC also minimum. MC cuts AC
at the minimum point of the AC.
 When AC starts to rise MC also rising but MC increase
faster than AC.

 It can be cleared by following diagram.

Long run cost
Long run is a period of time during which the quantities
of factor all of production are variable. In long run, all
factor of production are possible to change for production.
in the long run , output can be increased due to the
increase in factor of production.
Derivation of long run cost curve
(traditional theory)
Long run average cost; LAC
Long run average cost refers to the cost of production for per
unit output in long run. Or long run average cost is obtained
by dividing the long run total cost by the level of output. It is
derived from short run average cost curves.
LAC=LTC/Q
Where’ LAC= long run Average cost
LTC= long run total cost
Q= total output
Long run average cost curve is explained by following
diagram.