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In This Lecture…
 Concepts of Costs:
Economic Costs,
Accounting Costs, Sunk
Costs
 Short-run and Long-run
Costs: Total, ...
Business Firm
An entity that employs factors of
production (resources) to produce goods
and services to be sold to consume...
Why Do Business Firms Arise in
the First Place?
Firms are formed when benefits can be
obtained from individuals working as...
Economic Cost
Economic cost is the cost to a firm for
utilizing economic resources in
production, including opportunity co...
Accounting Cost
Accounting cost is that cost which
includes actual expenses plus depreciation
charges for capital equipmen...
Sunk Cost
A cost incurred in the past that cannot be
changed by current decisions and
therefore cannot be recovered.
Explicit and Implicit Cost
 Explicit Cost - A cost incurred when an
actual (monetary) payment is made.
 Implicit Cost - ...
Production and Cost:
Short and Long Run
 Short Run - A period of time in which
some inputs in the production process are
...
Short-run Cost
 The short-run costs are the costs over the
period during which some factors are in
fixed supply – like pl...
Long-run Cost
 The long-run costs are the costs over the
long period enough to permit changes in
all factors of productio...
Fixed and Variable Costs
 Fixed Costs – The cost
incurred in those inputs
whose quantity cannot be
changed as output chan...
Costs in Short-run
 Fixed Costs (FC) - Costs that do not vary with
output; the costs associated with fixed inputs.
 Vari...
Fixed Cost / Overhead Cost
 Fixed Costs (FC) - Costs that do not vary with
output; the costs associated with fixed inputs...
Fixed Cost / Overhead Cost
Cost
20
15
10
5

TFC

O

1

2

3

4

Output

 Total Fixed Cost Curve (TFC Curve) – Horizontal ...
Total Variable Cost/ Prime Cost
 Variable Cost (VC) - Costs that vary with
output; the costs associated with variable
inp...
Total Variable Cost/ Prime Cost
Cost
40

TVC

30
20
10

0

1

2

3

4

Output

 Total Variable Cost Curve (TVC Curve) – I...
Total Cost
 Total Cost (TC) - The sum of fixed costs
and variable costs. TC = TFC + TVC
 It is the aggregate of all cost...
Total Variable Cost/ Prime
Cost
Cost
50

TC
TVC

40
30
20

TFC

10

TFC

0

1

2

3

4

Output

 Total Cost Curve (TC Cur...
Fixed Cost vs. Variable Cost
Fixed Cost (FC)
1.
2.
3.
4.
5.
6.

FC are incurred in fixed FOP.
FC do not change with the
ch...
Average Fixed, Variable and Total
Cost
 Average Fixed Cost (AFC) - Total fixed
cost divided by quantity of output:
AFC = ...
Average Fixed Cost, Average Varible Cost & Average Cost
Average Fixed Cost, Average Variable Cost & Average Cost
Average Fixed Cost, Average Variable Cost & Average Cost
Average Fixed Cost, Average Varible Cost & Average Cost
Average Fixed Cost, Average Varible Cost & Average Cost
Average Fixed Cost, Average Variable Cost & Average Cost
Average Cost Curve is U-shaped
 Basis of AFC : AC includes AFC and AFC
falls continuously with increase in
output. Once A...
Average Cost Curve is U-shaped
 Basis of Law of Variable Proportion :
According to this Law initially when
variable facto...
AFC, AVC and AC Curves
Cost
AC
AVC
A

C
B

A1

C1
B1

AFC

A2
O

A4

C2
B2

C3

Output

 Short run AC curve is a vertical...
AC and AVC Curve
 AVC is a part of AC as AC = AVC + AFC
 The minimum point of AC will always be to
the right of minimum ...
Marginal Cost
 Marginal Cost (MC) - The change in total
cost that results from a change in output:
MC = ΔTC/Δ Q.
 Short ...
Marginal Cost
Output

TFC

TVC

TC

MC

0
1
2
3
4

10
10
10
10
10

0
10
18
30
45

10
20
28
40
55

10
8
12
15
Marginal Cost
Cost

MC

O
Output
 MC curve is U-shaped curve due to Law of Variable
Proportion
MC and AC
Cost

O

MC

a

b

AC

Output
MC and AC
 Both MC and AC are derived from TC.
MC= ΔTC/ΔQ and AC = TC/Q
 Both AC and MC curves are U-shaped, reflecting
...
MC and AVC
Cost

MC
AC
AVC

AFC
O

a

b

Output
MC and AVC
 Moth MC and AVC are derived from TVC.
MC= ΔTVC/ΔQ and AVC = TVC/Q
 Both AVC and MC curves are U-shaped, refl...
Production and Costs in the Long
Run
 In the short run, there are fixed costs and
variable costs; therefore, total cost i...
Long-Run Average Total Cost
(LRATC) Curve
A curve that shows the lowest (unit) cost
at which the firm can produce any give...
Long-Run Average Total Cost
Curve (LRATC )
 There are three
short-run average
total cost curves for
three different plant...
Long-Run Average Total Cost
Curve (LRATC )
 The long-run average
total cost curve is the
heavily shaded, blue
smooth curv...
Economies of Scale
 Economies of Scale exist when inputs are
increased by some percentage and output
increases by a great...
Why Economies of Scale?
Up to a certain point, long-run unit costs of
production fall as a firm grows. There are
two main ...
Why Diseconomies of Scale?
In very large firms,
managers often find it
difficult to coordinate
work activities,
communicat...
Economies of Scale

The lowest output level
at which average total
costs are minimized.
LAC and LMC
Costs

LMC

O

X

Increasing
Returns to Scale

LAC

Output
Decreasing
Returns to Scale

Constant Returns to Sc...
LAC and LMC
 Both LMC and LAC curves are flatter Ushaped curves are compared to SMC and
SAC
 LMC cuts LAC at its minimum...
Shifts in Cost Curves
A firm’s cost curves will shift if there is a
change in:
Taxes
Input prices
Technology.
9 costs class
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Transcript of "9 costs class"

  1. 1. In This Lecture…  Concepts of Costs: Economic Costs, Accounting Costs, Sunk Costs  Short-run and Long-run Costs: Total, Average and Marginal Costs  Cost Schedules, Cost Curves, Characteristics and their Relationships
  2. 2. Business Firm An entity that employs factors of production (resources) to produce goods and services to be sold to consumers, other firms, or the government.
  3. 3. Why Do Business Firms Arise in the First Place? Firms are formed when benefits can be obtained from individuals working as a team.
  4. 4. Economic Cost Economic cost is the cost to a firm for utilizing economic resources in production, including opportunity cost.
  5. 5. Accounting Cost Accounting cost is that cost which includes actual expenses plus depreciation charges for capital equipment.
  6. 6. Sunk Cost A cost incurred in the past that cannot be changed by current decisions and therefore cannot be recovered.
  7. 7. Explicit and Implicit Cost  Explicit Cost - A cost incurred when an actual (monetary) payment is made.  Implicit Cost - A cost that represents the value of resources used in production for which no actual (monetary) payment is made.
  8. 8. Production and Cost: Short and Long Run  Short Run - A period of time in which some inputs in the production process are fixed.  Long Run - A period of time in which all inputs in the production process can be varied (no inputs are fixed).
  9. 9. Short-run Cost  The short-run costs are the costs over the period during which some factors are in fixed supply – like plant, machinery etc.  It is a sum total of fixed cost and variable cost incurred by the producer in producing the commodity.
  10. 10. Long-run Cost  The long-run costs are the costs over the long period enough to permit changes in all factors of production.  It is a sum total variable cost incurred by the producer in producing the commodity.
  11. 11. Fixed and Variable Costs  Fixed Costs – The cost incurred in those inputs whose quantity cannot be changed as output changes.  Variable Costs – the cost incurred in those inputs whose quantity can be changed as output changes.
  12. 12. Costs in Short-run  Fixed Costs (FC) - Costs that do not vary with output; the costs associated with fixed inputs.  Variable Cost (VC) - Costs that vary with output; the costs associated with variable inputs.  Total Cost (TC) - The sum of fixed costs and variable costs. TC = TFC + TVC  Marginal Cost (MC) - The change in total cost that results from a change in output: MC = ΔTC/Δ Q.
  13. 13. Fixed Cost / Overhead Cost  Fixed Costs (FC) - Costs that do not vary with output; the costs associated with fixed inputs.  Overhead expenses, Wages/Salaries, Depreciation of Machinery, Insurance Amount etc. Output TFC 0 1 2 3 4 10 10 10 10 10
  14. 14. Fixed Cost / Overhead Cost Cost 20 15 10 5 TFC O 1 2 3 4 Output  Total Fixed Cost Curve (TFC Curve) – Horizontal line
  15. 15. Total Variable Cost/ Prime Cost  Variable Cost (VC) - Costs that vary with output; the costs associated with variable inputs.  Cost of direct labor, Running expenses like cost of raw materials, fuels etc. Output TVC 0 1 2 3 4 0 10 18 30 45
  16. 16. Total Variable Cost/ Prime Cost Cost 40 TVC 30 20 10 0 1 2 3 4 Output  Total Variable Cost Curve (TVC Curve) – Inverse Sshaped Curve
  17. 17. Total Cost  Total Cost (TC) - The sum of fixed costs and variable costs. TC = TFC + TVC  It is the aggregate of all costs of producing any given level of output Output TFC TVC TC 0 1 2 3 4 10 10 10 10 10 0 10 18 30 45 10 20 28 40 55
  18. 18. Total Variable Cost/ Prime Cost Cost 50 TC TVC 40 30 20 TFC 10 TFC 0 1 2 3 4 Output  Total Cost Curve (TC Curve) – Inverse S-shaped Curve
  19. 19. Fixed Cost vs. Variable Cost Fixed Cost (FC) 1. 2. 3. 4. 5. 6. FC are incurred in fixed FOP. FC do not change with the change in output. FC cannot be changed during short-run. FC can never be zero even at zero level of output. Production at the loss of FC may continue. TFC curve is parallel to x-axis. Variable Cost (VC) 1. 2. 3. 4. 5. 6. VC are incurred in variable FOP. VC changes with the change in the level of output. VC can be changed during short-run. VC can be zero at zero level of output. Production at the loss of VC will not continue. TVC curve is inverse S-shaped.
  20. 20. Average Fixed, Variable and Total Cost  Average Fixed Cost (AFC) - Total fixed cost divided by quantity of output: AFC = TFC / Q.  Average Variable Cost (AVC) - Total variable cost divided by quantity of output: AVC = TVC / Q.  Average Total Cost (ATC), or Unit Cost Total cost divided by quantity of output: ATC = TC / Q.
  21. 21. Average Fixed Cost, Average Varible Cost & Average Cost
  22. 22. Average Fixed Cost, Average Variable Cost & Average Cost
  23. 23. Average Fixed Cost, Average Variable Cost & Average Cost
  24. 24. Average Fixed Cost, Average Varible Cost & Average Cost
  25. 25. Average Fixed Cost, Average Varible Cost & Average Cost
  26. 26. Average Fixed Cost, Average Variable Cost & Average Cost
  27. 27. Average Cost Curve is U-shaped  Basis of AFC : AC includes AFC and AFC falls continuously with increase in output. Once AVC reaches its minimum point and starts rising, its rise is initially offset by the fall in AFC. Hence, AC continues to fall. After a certain point the rise in AFC becomes greater than the fall in AFC and AC starts rising
  28. 28. Average Cost Curve is U-shaped  Basis of Law of Variable Proportion : According to this Law initially when variable factor is combined with the fixed factor, production increases at an increasing rate implying AC falls till the best combination of fixed and variable factors is attained. Beyond this point, AC starts to rise.
  29. 29. AFC, AVC and AC Curves Cost AC AVC A C B A1 C1 B1 AFC A2 O A4 C2 B2 C3 Output  Short run AC curve is a vertical summation of AFC and AVC curves.  AVC = A2A4, AFC = A1A4. AC = AVC + AFC = A2A4 + A1A4 = AA4
  30. 30. AC and AVC Curve  AVC is a part of AC as AC = AVC + AFC  The minimum point of AC will always be to the right of minimum point of AVC  Both AVC and AC are U-shaped curves  The difference between AC and AVC decreases with the rise in the level of output as AC is the aggregation of AVC and AFC; and, AFC falls continuously as output increases. AVC and AC never meets each other as AFC is a rectangular hyperbola and can never touch x-axis
  31. 31. Marginal Cost  Marginal Cost (MC) - The change in total cost that results from a change in output: MC = ΔTC/Δ Q.  Short run MC can be estimated from TVC as well MC = TCn – TCn-1 = (TFCn + TVCn) - (TFCn-1 + TVCn-1) = (TFCn + TVCn) - (TFCn + TVCn-1) = TVCn - TVCn-1
  32. 32. Marginal Cost Output TFC TVC TC MC 0 1 2 3 4 10 10 10 10 10 0 10 18 30 45 10 20 28 40 55 10 8 12 15
  33. 33. Marginal Cost Cost MC O Output  MC curve is U-shaped curve due to Law of Variable Proportion
  34. 34. MC and AC Cost O MC a b AC Output
  35. 35. MC and AC  Both MC and AC are derived from TC. MC= ΔTC/ΔQ and AC = TC/Q  Both AC and MC curves are U-shaped, reflecting the law of variable proportion.  When AC is falling MC is below AC  When AC is rising MC is above AC  When AC is neither falling or rising AC=MC  There is a range over which AC is falling but MC is rising (ab)  MC curve cuts AC from its minimum point.
  36. 36. MC and AVC Cost MC AC AVC AFC O a b Output
  37. 37. MC and AVC  Moth MC and AVC are derived from TVC. MC= ΔTVC/ΔQ and AVC = TVC/Q  Both AVC and MC curves are U-shaped, reflecting the law of variable proportion.  When AVC is falling MC is below AVC  When AVC is rising MC is above AVC  When AVC is neither falling or rising AVC=MC  There is a range over which AVC is falling but MC is rising (ab)  MC curve cuts AVC from its minimum point.  The minimum point of AVC curve occurs to the right of the minimum point of MC curve.
  38. 38. Production and Costs in the Long Run  In the short run, there are fixed costs and variable costs; therefore, total cost is the sum of the two.  A period of time in which all inputs in the production process can be varied (no inputs are fixed). In the long run, there are no fixed costs, so variable costs are total costs.
  39. 39. Long-Run Average Total Cost (LRATC) Curve A curve that shows the lowest (unit) cost at which the firm can produce any given level of output. A firm attempts to maximize long run profits by selecting a short scale of plant that minimizes its costs.
  40. 40. Long-Run Average Total Cost Curve (LRATC )  There are three short-run average total cost curves for three different plant sizes.  If these are the only plant sizes, the longrun average total cost curve is the heavily shaded, blue scalloped curve.
  41. 41. Long-Run Average Total Cost Curve (LRATC )  The long-run average total cost curve is the heavily shaded, blue smooth curve.  The LRATC curve is not scalloped because it is assumed that there are so many plant sizes that the LRATC curve touches each SRATC curve at only one point.
  42. 42. Economies of Scale  Economies of Scale exist when inputs are increased by some percentage and output increases by a greater percentage, causing unit costs to fall.  Constant Returns to Scale exist when inputs are increased by some percentage and output increases by an equal percentage, causing unit costs to remain constant.  Diseconomies of Scale exist when inputs are increased by some percentage and output increases by a smaller percentage, causing unit costs to rise.
  43. 43. Why Economies of Scale? Up to a certain point, long-run unit costs of production fall as a firm grows. There are two main reasons for this:  Growing firms offer greater opportunities for employees to specialize.  Growing firms can take advantage of highly efficient mass production techniques and equipment that ordinarily require large setup costs and thus are economical only if they can be spread over a large number of units.
  44. 44. Why Diseconomies of Scale? In very large firms, managers often find it difficult to coordinate work activities, communicate their directives to the right persons in satisfactory time, and monitor personnel effectively.
  45. 45. Economies of Scale The lowest output level at which average total costs are minimized.
  46. 46. LAC and LMC Costs LMC O X Increasing Returns to Scale LAC Output Decreasing Returns to Scale Constant Returns to Scale
  47. 47. LAC and LMC  Both LMC and LAC curves are flatter Ushaped curves are compared to SMC and SAC  LMC cuts LAC at its minimum point  When LAC is falling LMC is below it  When LAC is rising LMC is above it  When LAC is neither falling or rising LMC = LAC
  48. 48. Shifts in Cost Curves A firm’s cost curves will shift if there is a change in: Taxes Input prices Technology.
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