Cost Concepts
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detailed explanation of cost concepts in micro economics....

detailed explanation of cost concepts in micro economics....

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Cost Concepts Presentation Transcript

  • 1. Cost Concepts
  • 2. Cost Concept:  It is used for analyzing the cost of a project in short and long run.
  • 3. Types of Cost:  Total fixed costs (TFC)  Average fixed costs (AFC)  Total variable costs (TVC)  Average variable cost (AVC)  Total cost (TC)  Average total cost (ATC)  Marginal cost (MC)
  • 4. Fixed Costs(FC) Fixed Cost denotes the costs which do not vary with the level of production. FC is independent of output. Eg: Depreciation, Interest Rate, Rent, Taxes  Total fixed cost (TFC): All costs associated with the fixed input.  Average fixed cost per unit of output: AFC = TFC /Output
  • 5. Variable Costs(VC) Variable Costs is the rest of total cost, the part that varies as you produce more or less. It depends on Output. Eg: Increase of output with labour.  Total variable cost (TVC): All costs associated with the variable input.  Average variable cost- cost per unit of output: AVC = TVC/ Output
  • 6. Total costs(TC) The sum of total fixed costs and total variable costs: TC = TFC + TVC Average Total Cost Average total cost per unit of output: ATC =AFC + AVC ATC = TC/ Output
  • 7. Marginal Costs  The additional cost incurred from producing an additional unit of output: MC = ∆ TC ∆ Output MC = ∆ TVC ∆ Output
  • 8. Typical Total Cost Curves  TVC,TC is always increasing:  First at a decreasing rate.  Then at an increasing rate
  • 9. Typical Average & Marginal Cost Curves
  • 10.  AFC is always  MC is generally declining at a increasing. decreasing rate.  MC crosses ATC and  ATC and AVC decline AVC at their minimum at first, reach a point. minimum, then  If MC is below the average increase at higher value: levels of output.  Average value will be  The difference decreasing. between ATC and AVC  If MC is above the average value: is equal to AFC.  Average value will be increasing.
  • 11. Production Rules for the Short-Run 1.If expected selling price < minimum AVC (which implies TR < TVC):  A loss cannot be avoided.  Minimize loss by not producing.  The loss will be equal to TFC. 2.If expected selling price < minimum ATC but > minimum AVC: (which implies TR > TVC but < TC)  A loss cannot be avoided.  Minimize loss by producing where MR = MC.  The loss will be between 0 and TFC.
  • 12. Contd… 3.If expected selling price > minimum ATC (which implies TR > TC):  A profit can be made.  Maximize profit by producing where: MR = MC
  • 13. Short Run Production Decisions SP SP
  • 14. Long Run Costs Curve:  All costs are variable in the long run.  There is only AVC in LR, since all factors are variable.  It is also called as Planning Curve or Envelope or scale curve.
  • 15. Production Rules for the Long-Run 1.If selling price > ATC (or TR > TC):  Continue to produce.  Maximize profit by producing where MR = MC. 2.If selling price < ATC (or TR < TC):  There will be a continual loss.  Sell the fixed assets to eliminate fixed costs.  Reinvest money is a more profitable alternative.
  • 16. Long Run Cost Curve Economies of scale Diseconomies of scale M M-optimum level of production
  • 17. Economies of Scale:  Economies of scale are the cost advantages that a firm obtains due to expansion. Diseconomies is the opposite.  Two types: 1. Pecuniary Economies of Scale: Paying low prices because of buying in large Quantity.
  • 18. 2.Real Economies of Scale: Refers to reduction in physical quantities of input , per unit of output when the size of the firm increases, as a result input cost minimized.
  • 19. Diseconomies: 1.Internal Economies: It is a condition which brings about a decrease in LRAC of the firm because of changes happening within the firm. e.g.As a company's scope increases, it may have to distribute its goods and services in progressively more dispersed areas. This can actually increase average costs resulting in diseconomies of scale.
  • 20. 2.External Economies: It is a condition which brings about a decrease in LRAC of the firm because of changes happening outside the firm. E.g. Taxation policies of Gov…