Cost Analysis

Date: 22/11/10

Importance of Cost Analysis:

Highest possible quality of products.
Finding lower cost methods for

production
The relation between the cost and output is known as Cost Function.

Cost Concepts:
Opportunity Cost Explicit and Implicit Cost Accounting and Economic Cost Fixed and Variable Cost

Types of Production Costs:

Total Cost

Total Fixed Cost

Total Variable Cost

Average Fixed Cost

Average Variable Cost Average Variable Cost Marginal Cost

Short Run vs. Long Run:

Short Run is the period of time in

which output can be increased or decreased by changing only the amount of variable factor. Long Run is defined as a period of time in which the quantities of all factors may be raised.

Short Run Total Cost:

To examine the cost behaviour in the short run the following three total costs concept are analyzed: 1. Total fixed cost 2. Total variable cost 3. Total cost

Short Run Total Cost Schedule

Units (Q) 0 1 2 3 4 5 6 7 8 TFC 50 50 50 50 50 50 50 50 50 TVC 0 20 35 60 100 145 190 237 284 TC 50 70 85 110 150 195 240 287 334

Behaviour of Total Cost:

TFC remains constant at all

levels of output TVC varies with the output TVC does not change in the same proportion TC varies in the same proportion as the TVC

Total Costs in the Short-Run

Short Run Per Unit Cost:

Average fixed cost
Average variable cost Average total cost Marginal cost

Short Run Per Unit Cost

Units 0 1 2 3 4 5 6 7 8 TFC 50 50 50 50 50 50 50 50 50 TVC 0 20 35 60 100 145 190 237 284 TC AFC AVC ATC 50 0 0 0 70 50 20 70 85 25 17.5 42.5 110 16.67 20 36.67 150 12.5 25 37.5 195 10 29 39 240 8.33 31.67 40 287 7.14 33.86 41 334 6.25 33.5 41.75 MC 20 15 25 40 45 45 47 47

Behaviour of short run average cost curves:

AFC Curve
AVC Curve

ATC Curve
MC Curve

Short Run Cost Graphs:

1.
AFC Q

MC ATC

3.

AVC

AFC Q

2.

MC intersects lowest point AVC of AVC and lowest point of ATC.

When MC < AVC, AVC declines Q When MC > AVC, AVC rises

Relationships Among Cost & Production Functions:

Q
AP & AVC are inversely
prod. functions

related. (ex: one input) AVC = WL /Q = W/ (Q/L) = W/ APL

AP

As APL rises, AVC falls

cost

MPL
AVC L MC

MP and MC are inversely

related MC = dTC/dQ = W dL/dQ = W / (dQ/dL) = W / MPL

As MPL declines, MC rises

cost functions

Long Run Costs:

All factor inputs are variable
Change in the scale of output

There is only variable cost as

total cost Long run is only a planning horizon

Long Run Cost Curves:

Features of Long Run Average Cost (LAC) Curve :

Tangent curve
Envelope curve

Planning curve
Minimum cost combination Flatter U-shaped

Long Run Cost Function (LAC) Envelope of SAC curves

Ave Cost SAC-small capital SAC-med. capital SAC-big capital

LAC--Envelope of SRAC curves

Q