costconcepts

7/25/2019 costconcepts

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Cost ConceptsCost Conc

epts


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Cost Concept:Cost Concept:

It is used for analyzing the cost of aIt is used for analyzing the cost of a

project in short and long run.project in short and long run.


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Types of Cost:Types of Cost:

Total fixed costs (TFC)Total fixed costs (TFC)

Average fixed costs (AFC)Average fixed costs (AFC)

Total variable costs (TVC)Total variable costs (TVC) Average variable cost (AVC)Average variable cost (AVC)

Total cost (TC)Total cost (TC)

Average total cost (ATC)Average total cost (ATC) Marginal cost (MC)Marginal cost (MC)


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Fixed Costs(FC)Fixed Costs(FC)

Fixed Cost denotes the costs which do not varyFixed Cost denotes the costs which do not vary

with the level of production. FC iswith the level of production. FC is

independent of output.independent of output.

g!g!Depreciation, Interest ate, ent, TaxesDepreciation, Interest ate, ent, Taxes

Total fixed cost (TFC):Total fixed cost (TFC):

!ll costs associated "ith the fixed input.!ll costs associated "ith the fixed input.

!#erage fixed cost!#erage fixed cost per unit of output:per unit of output:

!FC $ TFC %&utput!FC $ TFC %&utput


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'ariale Costs('C)'ariale Costs('C)'ariale Costs is the rest of total cost, the part that'ariale Costs is the rest of total cost, the part that

#aries as you produce ore or less. It depends on#aries as you produce ore or less. It depends on

&utput.&utput.

*g: Increase of output "ith laour.*g: Increase of output "ith laour.

Total #ariale cost (T'C):Total #ariale cost (T'C):

!ll costs associated "ith the #ariale!ll costs associated "ith the #ariale

input.input.

!#erage #ariale cost!#erage #ariale cost+ cost per unit of output:+ cost per unit of output:

!'C $ T'C% &utput!'C $ T'C% &utput


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Total costs(TC)Total costs(TC)

The su of total fixed costs and totalThe su of total fixed costs and total#ariale costs:#ariale costs:

TC $ TFC T'CTC $ TFC T'C

!#erage Total Cost!#erage Total Cost

!#erage total cost per unit of output:!#erage total cost per unit of output:

!TC $!FC !'C!TC $!FC !'C !TC $ TC% &utput!TC $ TC% &utput


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-arginal Costs-arginal Costs

The additional cost incurred fro"The additional cost incurred fro"producing an additional unit of output!producing an additional unit of output!

MC #MC # TCTC

$utput$utput

MC #MC # TVCTVC

$utput$utput


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Typical Total Cost Cur#esTypical Total Cost Cur#es

T'C,TC is al"ays increasing:T'C,TC is al"ays increasing: First at a decreasing rate.First at a decreasing rate. Then at an increasing rateThen at an increasing rate


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Typical !#erage -arginal CostTypical !#erage -arginal Cost

Cur#esCur#es


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!FC is al"ays!FC is al"ays

declining at adeclining at adecreasing rate.decreasing rate.

!TC and !'C decline!TC and !'C decline

at first, reach aat first, reach a

iniu, theniniu, thenincrease at higherincrease at higher

le#els of output.le#els of output.

The differenceThe difference

et"een !TC and !'Cet"een !TC and !'C

is e/ual to !FC.is e/ual to !FC.

-C is generally-C is generally

increasing.increasing. -C crosses !TC and-C crosses !TC and

!'C at their iniu!'C at their iniu

point.point.

If -C is elo" the a#erageIf -C is elo" the a#erage#alue:#alue:

!#erage #alue "ill e!#erage #alue "ill e

decreasing.decreasing.

If -C is ao#e the a#erageIf -C is ao#e the a#erage

#alue:#alue: !#erage #alue "ill e!#erage #alue "ill e

increasing.increasing.


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0roduction ules for the 1hort+un0roduction ules for the 1hort+un

2.If expected selling price 3 iniu !'C ("hich iplies T 32.If expected selling price 3 iniu !'C ("hich iplies T 3T'C):T'C):

! loss cannot e a#oided.! loss cannot e a#oided.

-iniize loss y-iniize loss y not producingnotproducing..

The loss "ill e e/ual to TFC.The loss "ill e e/ual to TFC.

4.If expected selling price 3 iniu !TC ut 5 iniu !'C:4.If expected selling price 3 iniu !TC ut 5 iniu !'C:

("hich iplies T 5 T'C ut 3 TC)("hich iplies T 5 T'C ut 3 TC)

! loss cannot e a#oided.! loss cannot e a#oided.

-iniize loss y producing "here - $ -C.-iniize loss y producing "here - $ -C.

The loss "ill e et"een 6 and TFC.The loss "ill e et"een 6 and TFC.


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Contd%Contd%7.If expected selling price 5 iniu !TC ("hich7.If expected selling price 5 iniu !TC ("hich

iplies T 5 TC):iplies T 5 TC):

! profit can e ade.! profit can e ade.

-axiize profit y producing "here:-axiize profit y producing "here:

- $ -C- $ -C


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1hort un 0roduction Decisions1hort un 0roduction Decisions

SPSPSP


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Long Run Costs Curve:Long Run Costs Curve:

All costs are variable in the long run.All costs are variable in the long run.

There is only AVCThere is only AVC in &' since all factorsin &' since all factors

are variable.are variable. t is also called as *lanning Curve ort is also called as *lanning Curve or

nvelope or scale curve.nvelope or scale curve.


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0roduction ules for the 8ong+un0roduction ules for the 8ong+un

2.If selling price 5 !TC (or T 5 TC):2.If selling price 5 !TC (or T 5 TC):

Continue to produce.Continue to produce.

-axiize profit y producing "here-axiize profit y producing "here- $ -C.- $ -C.

4.If selling price 3 !TC (or T 3 TC):4.If selling price 3 !TC (or T 3 TC):

There "ill e a continual loss.There "ill e a continual loss.

1ell the fixed assets to eliinate fixed costs.1ell the fixed assets to eliinate fixed costs. ein#est oney is a ore profitaleein#est oney is a ore profitale

alternati#e.alternati#e.


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8ong un Cost Cur#e8ong un Cost Cur#e

-+optiu le#el of production-+optiu le#el of production

--*conoies of scale Diseconoies of scale


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*conoies of 1cale:*conoies of 1cale:

*conoies of scale*conoies of scaleare the costare the costadvantages that a fir" obtains due toadvantages that a fir" obtains due to

expansion.expansion. +isecono"ies+isecono"iesis the opposite.is the opposite.

Two types!Two types!,. *ecuniary cono"ies of -cale!,. *ecuniary cono"ies of -cale!

*aying low prices because of buying*aying low prices because of buying

in large uantity.in large uantity.


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/.'eal cono"ies of -cale!/.'eal cono"ies of -cale! 'efers to reduction in physical 0uantities'efers to reduction in physical 0uantities

of input per unit of output when the si1e of theof input per unit of output when the si1e of the

fir" increases as a result input cost "ini"i1ed.fir" increases as a result input cost "ini"i1ed.


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+isecono"ies!+isecono"ies!

,.nternal cono"ies! t is a condition which brings about,.nternal cono"ies! t is a condition which brings abouta decrease in &'AC of the fir" because of changesa decrease in &'AC of the fir" because of changes

happening within the fir".happening within the fir".

e.g.As a co"pany2s scope increases it "ay have toe.g.As a co"pany2s scope increases it "ay have to

distribute its goods and services in progressively "oredistribute its goods and services in progressively "oredispersed areas. This can actually increase average costsdispersed areas. This can actually increase average costs

resulting in disecono"ies of scale.resulting in disecono"ies of scale.


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/.xternal cono"ies!/.xternal cono"ies!

t is a condition which brings about at is a condition which brings about a

decrease in &'AC of the fir" because ofdecrease in &'AC of the fir" because ofchanges happening outside the fir".changes happening outside the fir".

.g. Taxation policies of 3ov%.g. Taxation policies of 3ov%

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