Economics Presentation

Topic : Concepts of Cost

1. Concept of Cost
⮚Output needs inputs.
⮚Broadly , there are two types of inputs. a. factor
inputs( land ,labour, capital, and
entrepreneurship, called factors of production), b.
non-factor inputs(raw material).
⮚Cost refers to the expenditure incurred by a
producer on the factor as well as non-factor inputs
for a given output of a commodity.
❑Explicit and Implicit
⮚AllCost
inputs may not be purchased from the market. A producer may use
some self-owned inputs.
⮚Example : Instead of hired workers from the market , producer may use his
family labour. Likewise , a producer may use his own land instead of taking
it on lease.
⮚Expenditure incurred by the producer on the purchase of inputs from the
market is called explicit cost.
⮚Estimated expenditure on the use of self-owned inputs is called implicit
cost.
⮚In economics , total cost is estimated considering both its elements: explicit
cost and implicit cost.

Total cost= Explicit cost + Implicit cost

❑ Selling Cost and Production Cost
⮚Selling costs are different production costs.
⮚Selling costs refer to the expenditure incurred by
the producer to promote sale of the commodity.
Example : expenditure on advertisement.
⮚Production costs refer to the expenditure
incurred by a producer on the inputs for
producing a given level of output.
2. Short Run Costs
⮚Short run is period of time during which some factors
are fixed and some are variable.
⮚Accordingly , short run costs have two components,1.
fixed costs, referring to expenditure on fixed factors, and
2. variable costs , referring to expenditure on variable
factors.
⮚Thus ,TC= Total Cost
TFC= Total Fixed Cost (TC=TFC+TVC)
TVC=Total Variable Cost

Let’s discuss the details of fixed costs and variable costs

❖Fixed Costs
✔Costs related to the use of fixed factors are known as fixed costs.
✔These are also called supplementary costs, or overhead costs, or
indirect costs.
✔These costs do not change with the change in output .
✔Fixed costs are incurred even when output is zero.
✔For example : In a carpet manufacturing firm, a machine is installed
as a fixed factor. Lets assume that it can make 6 carpets a day and
that cost of hiring the machine is rupees 500 per day . Obviously
rupees 500 per day is the fixed cost that the producer has to incur
even when no carpet is made in a day. Between 0-6 carpets in a day,
the fixed cost would remain rupees 500.
Table 1. Total fixed
cost
unit of output Total fixed
cost(RS)
0 10
1 10
2 10
3 10
4 10
5 10
6 10

TFC is a horizontal straight line parallel to X- axis ,showing that total fixed cost is constant at all levels of
output. It is = RS 10, even when output is zero.
❖ Variable
costs
✔Variable costs are those costs which are related to the use
of variable factors.
✔Variable costs change with a change in the volume of
output.
✔As output increases , these costs also increase and as the
output decreases, these costs also decrease.
✔When output is zero , these costs are also zero.
✔These costs are called prime costs or direct costs.
Table 2. Total variable
cost Unit of output Total variable
cost(RS)
0 0
1 10
2 18
3 24
4 28
5 32
6 38

TVC increases with increases in output . It is =RS 10, when output =1 unit and is =RS 38 , when output = 6 units.
Between 0-A, TVC increases at a decreasing rate. Beyond point A, TVC increases at an increasing rate.
❖ Table 3.Behaviour of fixed cost,
variable cost, total cost.
Output(unit Fixed cost(RS) Variable Total
s) cost(RS) cost(RS)
0 10 0 10
1 10 10 20
2 10 18 28
3 10 24 34
4 10 28 38
5 10 32 42
6 10 38 48

TC= TFC+TVC
TFC is constant at all levels of output.
TVC increases as output increases.
TC is parallel to TVC . It shows that the difference between TC and TVC (=TFC) is constant.
❖ Average ⮚ Cost per unit of output is called.
⮚ AC= TC/Q [ here , AC= average cost

Cost(AC)
TC= total cost
Q= quantity of the output]
⮚ Average cost is the cost per unit of output
produced. It is also called unit cost of
production.

Table 4. estimation of AC when TC is given

❖Fixed and variable Components of AC
Average cost is the sum total of average fixed cost and average variable cost , i.e. AC= AFC+AVC

1. AVERAGE FIXED COST: Average fixed cost is the fixed cost per unit of output.
AC=TFC/Q
Table 5. average fixed cost {here , AFC= average fixed cost
Total TFC= total fixed cost
Output(uni Average
t) fixed cost fixed Q= quantity
(RS) cost(RS)
1 10 10
2 10 5
3 10 3.3
4 10 2.5
5 10 2
6 10 1.67
7 10 1.43
8 10 1.25
 Average variable cost is the variable cost per unit of
2. Average variable cost output.
AVC=TVC/Q
Table 6.average variable cost here, AVC= average variable cost
Total
TVC= total variable cost
Output Average
(units) variable variable Q= quantity
cost(RS) cost(RS)
1 10 10
2 18 9
3 24 8
4 28 7
5 32 6.4
6 38 6.3
7 46 6.6
8 62 7.7

⮚ AVC curve is U- shaped . This is in accordance with the law of variable proportions. It falls so long as returns
to a factor are increasing. It rises when return to a factor are decreasing.
3. AC as the summation of AFC and
AFC
•AC curve is a vertical summation of AFC and AVC curves.
❖Marginal Marginal cost is the change in total cost when
cost an additional unit of output is produced.

Table 7. marginal cost

output Total Total Total Margin
fixed variable cost al cost
cost cost
0 10 0 10 _
1 10 10 20 10
2 10 18 28 8
3 10 24 34 6
4 10 28 38 4
5 10 32 42 4
6 10 38 48 6
7 10 46 56 8
8 10 62 72 16
❖ Relation between Average, Marginal, Total
Cost
Relation between AC and MC
Table 8. relation between AC and MC
output Total cost Average Margina
cost l cost
0 10 _ _
1 20 20 10
2 28 14 8
3 34 11.3 6
4 38 9.5 4
5 42 8.4 4
6 48 8 6
7 56 8 8
8 72 9 16
Relationship between AVC and
MC
Relation between total cost and marginal
cost
Thank you