Cost

N. DURGA CHAITANYA PRASADAsst. Professor, DMA, SITE

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Presentation onCOST ANALYSIS

COST ANALYSIS

Cost refers to the amount of expenditure incurred in acquiring some thing

The expenditure incurred to produce an output or provide service

Thus the cost incurred in connection with raw material, labour, other heads constitute the overall cost of production

A managerial economist must have a clear understanding of the different cost concepts for clear business thinking and proper application

Output is an important factor which influences the cost

WHAT IS COST

Where C= CostS= Size of Plant / Scale of operationO= Output levelP= Prices of inputsT= Technology

COST INPUT OUT RELATIONSHIP

),,,( TPOSC

Opportunity Costs and Outlay CostExplicit and Implicit/ Imputed CostHistorical Cost and Replacement CostShort Run and Long run CostsOut of Pocket and Book CostsFixed Cost and Variable CostsPast and Future CostsTraceable Cost and Common CostsAvoidable Costs and Unavoidable CostsControllable Cost and Uncontrollable CostIncremental Cost and Suck CostsTotal, Average and Marginal CostsAccounting and Economic Costs

COST CONCEPTS

Opportunity Costs and Outlay Cost

COST CONCEPTS

Out lay costs, also known as actual costs or absolute costs. These are the payments made for labour, material, plant, transportation etc. All these are appearing in the books of accounts.

Opportunity cost implies the earning foregone on the next best alternative has the present option been undertaken

0pportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices.

http://en.wikipedia.org/wiki/Activity

http://en.wikipedia.org/wiki/Sacrifice

http://en.wikipedia.org/wiki/Mutually_exclusive

Opportunity Costs and Outlay Cost

COST CONCEPTS

1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.

2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%).

The short-run defined as that period during which the physical capacity of the firm is fixed and the output can be increased only by using the existing capacity more intensively.

The cost concepts, generally used in the cost behaviour, are total cost, average cost and marginal cost.

TC(Total Cost):Total cost is the actual money spends to produce a

particular quantity of output.Total cost is the summation of fixed and variable costsTC = TFC+ TVC TFC(Total Fixed Cost):Up to a certain level of production total fixed costs, i.e the

cost of plant, building, equipment etc. remain fixed. TVC(Total Variable Cost):But the total variable cost i.e the cost of labour, raw

material etc with the variation in output.

COST OUTPUT RELATION IN SHORT RUN

Average cost is the total cost per unit. It can be found out as follows

Average Cost=The average fixed cost keeps coming

down as the production increases and the variable cost will remain constant at any level of output. AFC= AVC=

Marginal cost is the additional of product. It can be arrived by dividing the change in total cost by the change in total output. MC=


QTC

QTFC

QTVC

QTC


1 2 3

Q TFC TVC

0 60 -1 60 202 60 633 60 484 60 675 60 906 60 132

4

TC2+3

608096108124150192

5

AVC3/1

-201816161822

6

AFC2/1

-603020151210

7

AC4/1

-804836313032

8

MC

-201612162642

QTVC

QTFC

QTC

QTC


1 2 3 4Q TFC TVC TC

2+30 60 - 601 60 20 802 60 63 963 60 48 1084 60 67 1245 60 90 1506 60 132 192


5 6 7 8AVC3/1

AFC2/1

AC4/1

MC

- - - -20 60 80 2018 30 48 1616 20 36 1216 15 31 1618 12 30 2622 10 32 42

COST OUTPUT RELATION IN LONG RUN

Long run is a period during which all inputs are variable including the ones which are fixed in short run.

In the long run firm can change its output according to its demand.

Over a long period, the size of the plant can be changed, unwanted building can be sold or let out, and the number of administrative and marketing staff can be increased or reduced.

In the long run the firm has to bring or purchase larger quantities of all in inputs.

In the long term all input factors are variable.


In the long run cost out-put relation therefore implies the relationship between the total cost and the total output.

In the long run, a firm has a number of alternatives in regard to the scale of operations.

In the long run average cost curve is composed of a series of short-run average cost curves.

In the short run average cost (SAC) curve applies to only one plant whereas the long-run average cost (LAC) curve takes into consideration many plants.

The long run cost-output relationship is shown graphically in the above with the help of LAC curve.

To draw an LAC curve we have to start with a number of SAC curves.

COST OUTPUT RELATION IN LONG RUNIn this figure it is assumed that technological

there are only three sizes of plants-small, medium and large, SAC1, for the small size, SAC2 for the medium size and SAC3 for the large size plant.

If the firm wants to produce OP units or less, it will choose the smallest plant. For an output OQ, the firm will opt for medium size plant.


It does not mean that the OQ production is not possible with small plant. Rather it implies that cost of production will be more with small plant compared to the medium plant.

For an output OR the firm will choose the largest plant as the cost of production will be more with medium plant. Thus the firm has a series of SAC curves.

The LAC drawn will be tangential to the entire families of SAC curves i.e. the LAC curve touches each SAC curve at one point, and thus it is known as Envelope Curve. And also known as Planning Curve as it series as guide to an entrepreneur in his planning to expand the production in future.

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