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    Theory of Cost

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    Gm Besacruz
    The document discusses the different types of costs involved in production, including money costs, explicit costs, implicit costs, total costs, fixed costs, variable costs, average costs, marginal costs, and their relationships. It provides definitions and formulas for calculating total cost, average cost, marginal cost, and discusses the differences between short-run and long-run costs.

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    Theory of Cost

    Uploaded by

    Gm Besacruz
    6 views24 pages
    The document discusses the different types of costs involved in production, including money costs, explicit costs, implicit costs, total costs, fixed costs, variable costs, average costs, marginal costs, and their relationships. It provides definitions and formulas for calculating total cost, average cost, marginal cost, and discusses the differences between short-run and long-run costs.

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    The document discusses the different types of costs involved in production, including money costs, explicit costs, implicit costs, total costs, fixed costs, variable costs, average costs, marginal costs, and their relationships. It provides definitions and formulas for calculating total cost, average cost, marginal cost, and discusses the differences between short-run and long-run costs.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    6 views24 pages

    Theory of Cost

    Uploaded by

    Gm Besacruz
    The document discusses the different types of costs involved in production, including money costs, explicit costs, implicit costs, total costs, fixed costs, variable costs, average costs, marginal costs, and their relationships. It provides definitions and formulas for calculating total cost, average cost, marginal cost, and discusses the differences between short-run and long-run costs.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 24

    In order to produce a good every firm

    makes use of factor of production so


    the amount spent on the use of factor
    of production is called factor of
    production cost of production mainly
    depends upon the quantity of
    production

    C=f(Q)
    Here, C=Cost
    F=Function
    Q=Quantity
    Cost Of Production

    Opportunity
    Money costs Real Costs
    costs

    Average Marginal
    Total Costs
    Costs costs

    Explicit Costs Implicit Cost


    According to Prof. Hanson

    The money cost of a producing a


    certain output of a commodity is
    the sum of all the payments to the
    factors of production engaged in
    the production of that commodity.
    Therefore, money costs include the following expenses:
    1.Depreciation and obsolescence charges.
    2.Power fuel charges.
    3.Wages and salaries.
    4.Cost of machinery, raw material etc.
    5.Expenses on advertising and publicity.
    6.Interest on capital.
    7.Expenses on electricity.
    8.Insurance charges.
    9.Transport costs.
    10.Packing charges.
    11.All types of taxes viz ; property tax , licence fees, exise duty.
    12.Rent on land.
    Money costs of a firm include two costs as following:
    1. Explicit costs
    2. Implicit costs
    1. Explicit costs :-
    According to LEFTWITCH
    “Explicit costs are those cash payments which
    firms make to outsiders for their services and Goods.”

    This cost includes, payment of raw material, taxes and depreciation


    charges, transportation, power, high fuel, advertising and so on.

    2. Implicit costs :-
    According to LEFTWITCH
    “Implicit costs are the costs of self-owned,
    self employed resources.”

    This cost includes the interest on his own capital, rent on his land,
    wages of his own labour etc.
    Theories of
    costs

    Cost of Production

    Total Cost Average Cost Marginal Cost


    Short run cost curves

    Total cost

    According to Dooley :
    “Total cost of production is the sum of all
    expenditures incurred in producing given volume of
    output.”
    Total costs is the combination of fixed costs and variable
    costs

    TC = FC+VC
    Here, TC= Total cost
    FC= Fixed cost
    VC=Variable cost
    Total Fixed Cost

    According to Anatol Murad :-


    “Fixed costs are costs which do not change
    with change in the quantity of
    output.”

    Total Variable Cost

    According to Dooley :-
    “Variable costs are one which vary as the level of
    output varies.”
    Output Fixed cost Variable cost Total cost

    0 40 0 40

    1 40 20 60

    2 40 30 70

    3 40 32 72

    4 40 34 74

    5 40 36 76

    6 40 38 78

    7 40 40 80

    8 40 46 86
    Average cost

    According to Dooley :-
    “The Average cost of production is the total cost per
    unit of output.”

    It includes average fixed cost and average variable cost.

    AC=TC/Q

    Here, AC=Average cost


    TC= Total cost
    Q= Output
    Average fixed cost

    “Average fixed cost is the total fixed cost divided by the number of units of
    output produced.”

    AFC=TFC/Q

    Here, AFC=Average fixed cost


    TFC=Total fixed cost
    Q=Output
    Average variable cost

    “Average variable cost is the total variable cost divided by the number of
    units of output produced.”

    AVC=TVC/Q

    Here, AVC=Average variable cost


    TVC=Total variable cost
    Q=Output
    Units TFC TVC TC AC(TC/Q) AFC(TFC/Q) AVC(TVC/
    Q)
    0 40 0 40 0 0 0

    1 40 20 60 60 40 20

    2 40 30 70 35 20 15

    3 40 32 72 24 13.3 10.7

    4 40 34 74 18.5 10.0 8.5

    5 40 36 76 15.2 8 7.2

    6 40 38 78 13.0 6.6 6.3

    7 40 40 80 11.4 5.7 5.7

    8 40 46 86 10.7 5 5.7

    9 40 48 88 9.8 4.4 5.4


    Marginal Cost
    “Marginal cost is the addition made to Total Cost caused by
    producing one more unit of output.”

    According to Ferguson:
    “Marginal cost is the addition to Total Cost due to the
    addition of one unit of output”

    MC=TCn –TCn-1

    Here, MC=Marginal Cost


    TCn=Total cost of ‘n’ units
    TCn-1= Total cost of ‘n-1’ units
    The derivation of MC can be studied with the help of following table:

    Units of output TC MC=(TC n - TCn-1)

    1 60 -

    2 70 10

    3 76 6

    4 78 2

    5 84 6

    6 90 6

    7 108 18

    8 130 22
    Relation between average and marginal cost

    The main points of relation between average and marginal cost are as under:
    1. Average cost and marginal cost can be calculated from total cost.
    2. When AC falls MC also falls.
    3. When AC arises MC also arises.
    4. MC cuts AC at its lowest point.
    5. When AC is constant MC becomes equal to AC.
    6. Use of MC and AC in price determination.
    7. Mutual interaction between MC and AC.
    Long run cost curves

    “Long run is a period in which there is a suficient time to alter the equipment
    and the scale or organisation with a view to produce different quantities of
    output.”

    Long run Total Cost

    The long run total cost of production is the minimum possible cost of
    producing any given level of output when all inputs are variable. Long run
    TC is always less than or equal to short run Total cost, but it is never more
    than STC.
    Long run Average cost curve

    Long run Average cost is the long run total cost divided by the level of output.

    LAC=LTC/Q

    According to Robert Awh :-


    “The Long run average cost curve shows the
    lowest average cost of producing output when
    all inputs can be varied freely.”
    Different names of LAC
    LAC also known as these two following names:
    1.Envelope curve
    2.Planning curve

    1.Envelope curve:-
    It envelopes all the SAC curves. It indicates that LAC
    cannot exceed SAC so this curve is called as envelope
    curve.

    2. Planning curve :-
    With the help of this curve a firm can plan as to which
    plant it should used to produce different quantities of
    output so that production is obtained at minimum cost.
    Long run marginal cost
    Long run marginal cost shows the change in total cost due to the
    production of one more unit of commodity.

    According to Robert Awh :-


    “Long run marginal cost curve is that
    which shows the extra cost incurred in producing one more
    unit of output when all inputs can be changed.”

    LMC= LTC/ Q

    Here, LMC= Long run marginal cost


    LTC = Change in long run total cost
    Q = Change in output
    Relation between LMC and LAC

    The relation between long run marginal cost and long run average cost
    is similar to that of what it is in short run AC and MC but the only
    difference in LAC and LMC is that long run marginal and average costs
    are more flatter than that of SAC and SMC. It is so because in long run
    all factors are variable.

    Relation between LMC and SMC

    SMC refers to the effect on total cost due to the production of one
    more unit of output on account of change in variable factors. When a
    firm selects a proper scale of plan in order to produce given quantity of
    output then at this level of output short run and long run marginal
    cost curves are equal.

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