Cost function Managerial Economics

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Cost function Managerial Economics

  1. 1.  Cost function may be defined as the relationship between costs of a product and output. C = F [Q]
  2. 2. SHORT RUN COST COST LONG RUN COST
  3. 3.   An analysis in which certain factors are assumed to be fixed during the period analyzed. In short run output can be increased or decreased by changing only the variable factors.
  4. 4. Fixed cost + Short run cost Variable cost = Total cost
  5. 5.   Fixed cost are those cost which do not change with changes in output. Fixed cost are otherwise called ‘supplementary cost’ or ‘over head costs’. Eg ; Rent on land and building , Insurance charges, Interest on fixed capital, Salary of permanent employees.
  6. 6.   Variable cost are those costs which changes with changes in output. Variable cost are also called ‘prime cost’. Eg; cost of raw materials, cost of power in production, wages of workers.
  7. 7.   Total cost is defined as the Total actual cost that must be incurred to produce a given quantity of output. Fixed cost and variable cost are formally called Total fixed cost and Total Variable cost. TC = TFC + TVC
  8. 8. UNITS OF OUTPUT TFC [Rs.] TVC [Rs.] TC [Rs.] 0 60 60 -60 = 0 60 1 60 100 -60 = 40 100 2 60 120 – 60 = 60 120 3 60 70 130 4 60 100 160 5 60 160 220 6 60 300 360
  9. 9. .............    TFC being fixed at Rs.60, remains the same at all levels of output . Thus, the TFC- curve is a straight line parallel to the x-axis. TVC – curve starts from the origin at zero output . It move upwards from left to right. The shape of TC –curve is the same as TVCcurve.
  10. 10. SHORT RUN AVERAGE COST AVERAGE FIXED COST AVERAGE VARIABLE COST AVERAGE FIXED COST
  11. 11.  AFC is the per unit fixed cost of producing a commodity. It is obtained by dividing the total fixed cost by the quantity of output [Q]. AFC = TFC Q
  12. 12.  AVC is the per unit variable cost of producing a commodity . It is obtained by dividing the total variable cost by the quantity of output. AVC = TVC Q
  13. 13.  AC is the sum total of AFC and AVC. AC = TC Q
  14. 14.  MARGINAL COST ; Marginal cost is the addition to total cost by the production of an additional unit of output. ;w MCn = TCn - TCn-1
  15. 15. Units of TFC producti [Rs] on TVC [Rs] TC [Rs] AFC [Rs] AVC [Rs] ATC [Rs] MC [Rs] O 60 0 60 - - - - 1 60 40 10 60 40 100 40 2 60 60 120 30 30 60 20 3 60 70 130 20 23.3 43.3 10 4 60 100 160 15 25 40 30 5 60 160 220 12 32 44 60 6 60 300 360 10 50 60 140
  16. 16.     The short –run MC curve will at first decline and the ATC and AVC at their minimum points. The AVC curve will go down , and then go up. AFC curve will decline as additional units are produced , and continue to decline. ATC curve initially will decline as the fixed cost are spread over a large number of units , but will go up as MC increase due to the law of diminishing returns.

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