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8/13/2019 Cost & Cost Curves
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PRESENTATION BYMANOJ KUMAR SUNUWAR
MAHENDRA AADARSHSA VIDHYASHRAM CAMPUSSATDOBATO, LALITPUR
NEPAL
Date: 2069-08-15
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BASIC CONCEPT OF COSTIn the process of production of goods and
services it requires the use of various
factors of production such as land, labour,
capital and entrepreneur/organization.
These factors of production helps inproduction process and as a reward they
get payment for their services.
Producer has to pay prices to these factorsof production such as rent for land, wages
for labour, interest for capital and profit for
entrepreneur.
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The sum of these payment made for various
factors of production is known as cost of
production.
In conclusion, the sum of the prices paid to theinputs like rent, wages, interest and profit by the
producer to produce goods and services is known
as cost of production.The term cost of production can be analyzed under
the following sub headings:
1. Money Cost:- The payment made in terms of money to the
inputs used in production in the form of rent,
wages, salaries, allowances, profit, interest and
rice of raw materials is known as mone cost.
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3. Explicit Cost:- Producer does not possess all factors of
production required in the process of productionof goods and services.
- At that time producer borrows factors of
productions from external sources and pays theremuneration for their services.
- The payment made for those factors of
production which are borrowed from external
sources in terms of money is called explicit cost.
- All explicit costs are written in the Book of
Accounts, which is very important in keeping
profit and loss account.
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If he uses, these factors for somebody else, he
gets remuneration for their services. Therefore,
economist calculate the costs of the factors of
production of ones own possession even when
they are used in own production process.
This cost is calculated on the basis of
opportunity cost and in this cost capital
consumption allowances is also included.
This cost is not included in Book of Account but
play vital role in business decisions.
5. Opp0rtunity Cost:This cost is known as the next best alternative
cost which is sacrificed by producer.
F l l t th t f
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For example: let us suppose that a farmer can
produce 300 kg of rice in one hector land by
using certain factors. If the farmer produces
maize at that land he can produce 200 kg ofmaize only by using same factors as before.
Here, cost of producing rice and maize is same.
In this situation, if farmer produce maize, thenhis opportunity cost of producing 200 kg maize
is 300 kg rice. And similarly, if he produce rice,
then his opportunity cost of producing 300 kg of
rice is 200 kg maize.
6. Accounting Cost:The cost which are necessary for accounting
purpose is known as accounting cost.
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It includes only direct cost or payment
made in-terms of money to the factors of
production. It does not include real cost
and the opportunity cost of self owned
resources or self employed resources.
For example: rent paid for land, factory
buildings, wages paid for labourers,
interest for capital, prices for rawmaterials, fuels, transportation etc. in form
of cash are the example of accounting cost.
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7. Economic Cost:Economic cost is the aggregate cost of
explicit and implicit cost. Such cost coversboth monetary cost and other services
provide by the producer including normal
profit.i.e. Economic Cost = Accounting Costs +
Implicit Costs.
Question:
What is cost and define various types of
costs.
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CONCPET OF FIXED AND VARIABLE COST In the process of production, a producer employs
or used various factors of production such as
land, labour, capital, organization, raw materialsetc.
These factors of production can be classified into
two categories. There are some factors whichcan be used for a longer period for producing
more than one batch of goods and services.
These factors do not change their form in oneuse are called fixed factors of production. The
fixed factors capital like machinery, land and
building and permanent staff are included in this
category.
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There are some other factors which can have
only one use, these are called variable factors
of production. The raw materials are includedin this category.
Hence, the cost of production is composed of
two cost fixed cost and variable cost.1. Fixed Cost:The amount of money value paid to the fixed
factors of production used in productionprocess is known as fixed cost.
This cost is also known as supplementary
cost or overhead cost.
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Fixed cost do not change with any change in
output. Fixed cost are made in the initial
phase of production so it must be paid even ifthe firmsoutput is zero.
Salary paid to the permanent staff,
managerial cost, rental payment, interest andsome portion of depreciation charge are the
examples of fixed cost.
2. Variable Cost:Variable cost is the price or money value paid
to the variable factors of production used in
the production process.
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Variable cost are directly related to the
production. So, variable cost remains zero at
zero level of production and it increases with the
increase in level of output.
It includes the payments made for raw
materials, fuel, power, transportation, wages and
other similar variable resources.
The main difference between variable and fixed
costs is only a short run phenomenon. Nothing
remains fixed in long run. That means all factors
of production became variable in long run.
Because, change would occur in the staff and
amount of capital.
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CONCEPT OF SHORT RUN COST AND LONGRUN COST1. CONCEPT OF SHORT RUN COST:Price or money value paid to the fixed and
variable factors of production in short run is
called short run cost.
Short run is that period where all factors ofproduction can not be changed. That means
some factors of production remains fixed and
some factors of production are changed.
Fixed cost remains unchanged along with
change in production of goods and services and
the variable cost changes along with change in
roduction of oods and services.
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Short run cost can be classified into following
three headings:
A. Short-Run Total CostB. Short-Run Average Cost and
C. Short-Run Marginal Cost
A. Short Run Total Cost: There are three types of cost falls under short
run total cost, which are as follows:
i. Short-Run Total Fixed Cost (STFC)
ii. Short-Run Total Variable Cost (STVC)
iii. Short-Run Total Cost (STC)
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i. Short-Run Total Fixed Cost (STFC): The total amount of price or money value paid
to the fixed factors in the process of productionin a short period is known as total fixed cost.
Total fixed cost remains constant/unchanged,
whatever be level of output.
To derive the TFC curve let us take help
following table:Quantity of Output (Q) TFC in Rs.
0 451 45
2 45
3 45
4 45
5 45
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In the above table total cost is Rs. 45 when
output is zero and the in output increase being
1, 2, 3, 4, 5 units but total fixed cost remains
unchanged i.e. Rs.45. By using above
information we can derive short run total fixed
cost curve as follows:
Graphically, TFC
OUTPUT
STFC
1 2 3O
45
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TVC curve is inverse S-shaped from origin, which
due to operation of law of variable proportion.
It can be represent with the help of followingtable:
Short Run Variable CostQuantity of Output Total Variable Cost (TVC) in Rs.
0 0
1 35
2 45
3 50
4 53
5 55
6 65
7 80
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In the above table when output is zero total variable
cost is also zero. When output level increases variable
cost also increases. In the table, variable cost is equal
to Rs. 35 when only 1 unit of output is produced andthey rise to Rs.80 when 7 units of output are produced.
Graphically,
0
10
20
30
40
50
60
70
80
90
0 1 2 3 4 5 6 7 8
Total Variable Cost (TVC) in Rs.
Total Variable Cost (TVC) in Rs.
TVC
Output
TVC Curve
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In the above figure, along x-axis we plot level of
output and along y-axis we plot TVC. Total variable
cost is represented by TVC curve. It start from
origin and increasing upward from left to right.
TVC curve seems like inverse S.
iii. Total Cost (TC): Total Cost is the sum of total fixed cost and total
variable cost at each level of output or production.
i.e. TC= TFC + TVC
At zero level of output, TC is equal to the firms
TFC. Then for each unit of output TC varies by
same amounts as varies in the variable cost.
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Short run total cost can be represent by following table:
Short Run Total Cost
Quantity of Output TFC TVC TC
0 45 0 45
1 45 35 80
2 45 45 90
3 45 50 95
4 45 53 98
5 45 55 100
6 45 65 110
7 45 80 125
8 45 100 145
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In the above table, TC increase at the same
direction of the increase in TVC because total
cost is the sum of TFC and TVC.
From above table we can derive the short run
total cost curve, which is shown below:
0
20
40
60
80
100
120
140
160
0 1 2 3 4 5 6 7 8 9
TFC
TVC
TC
Cost
Output
TC
TVC
TFC
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In the above figure, we plot output along x-
axis and we plot cost along y-axis. Where
we clearly see that TC is same shaped as ofTVC. TC curve starts above the origin
because of TFC. Inverse S-shaped TC
signifies that TC curve is explained by thelaw of diminishing returns in production.
Question:1. Define and draw TFC, TVC and TC curves.
2. Define fixed cost and variable cost with
the example.
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SHORT RUN PER UNIT COSTS There are four types of short run per unit costs,
which are as follows:
1. Short Run Average Fixed Cost (SAFC): Average Fixed Cost (AFC) is the per unit fixed
cost of production. AFC at each level of
production can be obtained by dividing the TFC
by corresponding level of output (Q).
i.e. AFC = TFC/Q
Total fixed cost is independent of output, so AFC
declines as long as production increases but
never became zero. In graphical representation
AFC curve is rectangular hyperbolic.
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To derive AFC curve, let us take help of following table:
Average Fixed CostQuantity of Output (Q) TFC AFC
0 45 -
1 45 45
2 45 22.5
3 45 15
4 45 11.2
5 45 9
6 45 7.5
7 45 6.4
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In the above table, as increase in output TFC
remains same but AFC decreases continuously
as increase in output but never be zero.
Graphically,AFC/TFC
OUTPUT
TFC
AFC
0
5
10
15
20
25
30
35
40
45
50
0 1 2 3 4 5 6 7 8
TFC 45
AFC 0
f
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In the above figure, along x-axis we plot output
and along y-axis we plot AFC and TFC. As
increase in output AFC continuously falls
downward from left to the right but never
touches both axis.
Which means, at very low level of output AFC is
very high but it declines continuously as
production increases but remains positive.
2. Short Run Average Variable Cost (SAVC): Average variable cost (AVC) is the per unit
variable cost of production.
It is calculated by dividing total variable cost
(TVC) by the corresponding level of output.
I i i ll AVC d d i h
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Initially AVC decreases and it reaches to
minimum point and finally it increases. hence,, it
is U shaped.
AVC curve can be derived with the help of
following table:
Average Variable CostQuantity of Output (Q) TVC AVC
0 0 -
1 35 35
2 60 30
3 75 25
4 80 205 90 18
6 105 17.5
7 130 18.6
8 180 22.5
9 250 27.810 340 34
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G hi l d i ti f AVC
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Graphical derivation of AVC curve:
TVC
OUTPUT
0
50
100
150
200
250
300
350
400
0 2 4 6 8 10 12
TVC
TVC
0
5
10
15
20
25
30
35
40
0 2 4 6 8 10 12
AVC
AVC -
OUTPUT
AVC
I th b fig l g i l t t t d
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In the above figure, along x-axis we plot output and
along y-axis we plot cost. In the figure initially
average cost falls downward from left to right it
reaches to minimum point and finally it starts torise upward from left to right.
Initially average variable cost is declining due to the
operation of law of increasing returns and AC goes
on decreasing due to operation of law of decreasingreturns.
Due to this reason AVC curve is U shaped as shown
in the figure above.
3. Short Run Average Cost (AC): Average cost is the per-unit cost of production. It is
obtained by dividing total cost of production by total
output produced.
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Short Run Average CostQuantity of Output TC AC
0 45 -
1 80 80
2 90 45
3 95 31.67
4 98 24.5
5 100 20
6 120 20
7 150 21.438 180 22.5
9 210 23.3
In the above table initially average cost is
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In the above table, initially average cost is
decreasing it reaches to its minimum point,
that is at 5th unit of output AC is minimum
and at 6thunit of output AC remains constant
and finally starts to increase that is after 8th
unit of output AC goes on increasing.
Initially average cost is declining due to the
operation of law of increasing returns and AC
goes on decreasing due to operation of law ofdecreasing returns. Due to this reason AC
curve is U shaped as shown in the figure
below.
250cost
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In the above figure initially AC curve declines, itreaches to a minimum point and subsequently
rises again. Thus AC curve is U-Shaped. Which is
shown by SAC CURVE in above figure.
0
50
100
150
200
0 1 2 3 4 5 6 7 8 9 10
TC 45
AC
cost
STC CURVE
output
SAC CURVE
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300TVC
ost
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0
50
100
150
200
250
3
0 1 2 3 4 5 6 7 8 9 10
TVC
TVC
0
5
10
15
20
25
30
35
40
0 1 2 3 4 5 6 7 8 9 10
AVC -
AVC -
Output
TC
Output
Margina
lCost
MC
y urve s - ape
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We clearly observe that AFC curve's shape is
rectangular hyperbola, AVC and AC curve's shape is U.
The main reasons behind U-shaped AC curve is asfollows:
1. Due to Operation of Law of Variable Proportion:
Due to the operation of law of variable proportion AVC
and AC curves are U shaped.
According to this law when output increases at
increasing rate at that time cost will increases at
decreasing rate, when total product is maximum atthat time cost will be minimum and when total product
starts to decline at that time at that time cost will
increases at increasing rate. Thus, AC curve is U
shaped.
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3. Economies and Diseconomies of Scale:
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Due to the economies in production average cost
declines it reaches its minimum point and finally due
to the diseconomies in production average costincreases and hence, AC curve is U shaped.
Economies in production refers to the increase in
efficiency of technology, efficiency of labor, managerial
efficiency, market efficiency and etc.
Initially, efficiency of technology, efficiency of labor,
managerial efficiency, market efficiency and etc.
increases due to which cost declines as a result ACcurves slopes down it reaches to its minimum point,
beyond the minimum point efficiency starts to decline
as a result cost starts to increase and hence, AC curve
is U shaped.
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3 When AC starts to increase MC increases faster
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3. When AC starts to increase, MC increases faster
than that of AC.
4. MC cuts AC from below at its minimum point.
5. Both AC and MC shows similar characteristics
i.e. both are initially declines reaches to minimum
points and finally starts to increase. That means
both curve has similar shape, i.e. U Shape.