AR Alamin

1. Total Cost: In economics, the total cost (TC) is the total economic cost of production. Total cost is
the total opportunity cost of each factor of production as part of its fixed or variable costs. It
consists of variable costs and fixed costs.
Types of Costs: Variable costs change according to the quantity of goods produced; fixed costs are
independent of the quantity of goods being produced. Total cost is the sum of fixed and variable
costs.
Differentiate Fixed costs and Variable Costs
Variable costs change according to the quantity of a good or service being produced. The amount of
materials and labour that is needed for to make a good increases in direct proportion to the number
of goods produced. The cost “varies” according to production.
A cost that changes with the change in volume of activity of an organization. Variable cost (VC)
changes according to the quantity of a good or service being produced. It includes inputs like labour
and raw materials. Variable costs are also the sum of marginal costs over all of the units produced
(referred to as normal costs). For example, in the case of a clothing manufacturer, the variable costs
would be the cost of the direct material (cloth) and the direct labour. The amount of materials and
labour that is needed for each shirt increases in direct proportion to the number of shirts produced.
The cost “varies” according to production.
Fixed costs are independent of the quality of goods or services produced. Fixed costs (also referred
to as overhead costs) tend to be time related costs including salaries or monthly rental fees. Fixed
costs are only short term and do change over time. The long run is sufficient time of all short-run
inputs that are fixed to become variable. Business expenses that are not dependent on the level of
goods or services produced by the business. Fixed costs (FC) are incurred independent of the
quality of goods or services produced. They include inputs (capital) that cannot be adjusted in the
short term, such as buildings and machinery. Fixed costs (also referred to as overhead costs) tend to
be time related costs, including salaries or monthly rental fees. An example of a fixed cost would be
the cost of renting a warehouse for a specific lease period. However, fixed costs are not permanent.
They are only fixed in relation to the quantity of production for a certain time period. In the long
run, the cost of all inputs is variable. Total Costs (TC) = Fixed Costs(FC)+ Variable Costs (VC)
Marginal Costs: Marginal cost is the cost of producing an extra unit. If the total cost of 3 units is
1550, and the total cost of 4 units is 1900. The marginal cost of the 4th unit is 350.
Opportunity Cost: Opportunity cost is the next best alternative foregone. If you invest £1million in
developing a cure for pancreatic cancer, the opportunity cost is that you can’t use that money to
invest in developing a cure for skin cancer.
Economic Cost: Economic cost includes both the actual direct costs (accounting costs) plus the
opportunity cost. The economic cost of a decision that a firm makes depends on the cost of the
alternative chosen and the benefit that the best alternative would have provided if chosen. Economic
cost is the sum of all the variable and fixed costs (also called accounting cost) plus opportunity
costs. Components of Economic Costs: Economic cost takes into account costs attributed to the
alternative chosen and costs specific to the forgone opportunity. Before making economic decisions,
there are a series of components of economic costs that a firm will take into consideration. These
components include:
• Total cost (TC): total cost equals total fixed cost plus total variable costs (TC = TFC +
TVC).
• Variable cost (VC): the cost paid to the variable input. Inputs include labor, capital,
materials, power, land, and buildings. Variable input is traditionally assumed to be labor.
• Total variable cost (TVC): same as variable costs.

2. • Fixed cost (FC): the costs of the fixed assets (those that do not vary with production).
• Total fixed cost (TFC): same as fixed cost.
• Average cost (AC): total costs divided by output (AC = TFC/q + TVC/q).
• Average fixed cost (AFC): the fixed costs divided by output (AFC = TFC/q). The average
fixed cost function continuously declines as production increases.
• Average variable cost (AVC): variable costs divided by output (AVC = TVC/q). The average
variable cost curve is normally U-shaped. It lies below the average cost curve, starting to the
right of the y axis.
• Marginal cost (MC): the change in the total cost when the quantity produced changes by one
unit.
Accounting Costs: this is the monetary outlay for producing a certain good. Accounting costs will
include your variable and fixed costs you have to pay.
Sunk Costs: These are costs that have been incurred and cannot be recouped. If you left the
industry, you could not reclaim sunk costs. For example, if you spend money on advertising to enter
an industry, you can never claim these costs back. If you buy a machine, you might be able to sell if
you leave the industry. ATC (Average Total Cost) = Total Cost / quantity, AVC (Average Variable
Cost) = Variable cost / quantity, AFC (Average Fixed Cost) = Fixed cost / quantity
Average and Marginal Cost: Marginal cost is the change in total cost when another unit is
produced; average cost is the total cost divided by the number of goods produced.
Distinction between Marginal and Average costs
• The marginal cost is the cost of producing one more unit of a good.
• Marginal cost includes all of the costs that vary with the level of production. For example, if
a company needs to build a new factory in order to produce more goods, the cost of building
the factory is a marginal cost.
• Economists analyse both short run and long run average cost. Short run average costs vary in
relation to the quantity of goods being produced. Long run average cost includes the
variation of quantities used for all inputs necessary for production.
• When the average cost declines, the marginal cost is less than the average cost. When the
average cost increases, the marginal cost is greater than the average cost. When the average
cost stays the same (is at a minimum or maximum), the marginal cost equals the average
cost.
Marginal cost: The increase in cost that accompanies a unit increase in output; the partial
derivative of the cost function with respect to output. Additional cost associated with
producing one more unit of output. In economics, marginal cost is the change in the total
cost when the quantity produced changes by one unit. It is the cost of producing one more
unit of a good. Marginal cost includes all of the costs that vary with the level of production.
For example, if a company needs to build a new factory in order to produce more goods, the
cost of building the factory is a marginal cost. The amount of marginal cost varies according
to the volume of the good being produced. Economic factors that impact the marginal cost
include information asymmetries, positive and negative externalities, transaction costs, and
price discrimination. Marginal cost is not related to fixed costs.
Average cost: In economics, average cost or unit cost is equal to total cost divided by the
number of goods produced. The average cost is the total cost divided by the number of
goods produced. It is also equal to the sum of average variable costs and average fixed costs.
Average cost can be influenced by the time period for production (increasing production
may be expensive or impossible in the short run). Average costs are the driving factor of
supply and demand within a market. Economists analyse both short run and long run
average cost. Short run average costs vary in relation to the quantity of goods being

3. produced. Long run average cost includes the variation of quantities used for all inputs
necessary for production.
Relationship Between Average and Marginal Cost: Average cost and marginal cost impact one
another as
production
fluctuate:
Cost curve: This
graph is a cost
curve that shows
the average total
cost, marginal
cost, and
marginal
revenue. The
curves show how
each cost
changes with an
increase in
product price
and quantity produced. When the average cost declines, the marginal cost is less than the average
cost. When the average cost increases, the marginal cost is greater than the average cost. When the
average cost stays the same (is at a minimum or maximum), the marginal cost equals the average
cost.
Differences Between Short Run and Long Run Costs: Long run costs have no fixed factors of
production, while short run costs have fixed factors and variables that impact production.
In the short run, there are both fixed and variable costs.
In the long run, there are no fixed costs.
Efficient long run costs are sustained when the combination of outputs that a firm produces results
in the desired quantity of the goods at the lowest possible cost.
Variable costs change with the output. Examples of variable costs include employee wages and
costs of raw materials.
The short run costs increase or decrease based on variable cost as well as the rate of production. If a
firm manages its short run costs well over time, it will be more likely to succeed in reaching the
desired long run costs and goals.
Long Run Costs: Long run costs are accumulated when firms change production levels over time
in response to expected economic profits or losses. In the long run there are no fixed factors of
production. The land, labour, capital goods, and entrepreneurship all vary to reach the long run cost
of producing a good or service. The long run is a planning and implementation stage for producers.
They analyse the current and projected state of the market in order to make production decisions.
Efficient long run costs are sustained when the combination of outputs that a firm produces results
in the desired quantity of the goods at the lowest possible cost. Examples of long run decisions that
impact a firm’s costs include changing the quantity of production, decreasing or expanding a
company, and entering or leaving a market.
Short Run Costs: Short run costs are accumulated in real time throughout the production process.
Fixed costs have no impact of short run costs, only variable costs and revenues affect the short run
production. Variable costs change with the output. Examples of variable costs include employee
wages and costs of raw materials. The short run costs increase or decrease based on variable cost as

4. well as the rate of production. If a firm manages its short run costs well over time, it will be more
likely to succeed in reaching the desired long run costs and goals.
Differences: The main difference between long run and short run costs is that there are no fixed
factors in the long run; there are both fixed and variable factors in the short run. In the long run the
general price level, contractual wages, and expectations adjust fully to the state of the economy. In
the short run these variables do not always adjust due to the condensed time period. In order to be
successful a firm must set realistic long run cost expectations. How the short run costs are handled
determines whether the firm will meet its future production and financial goals.
Economies and Diseconomies of Scale
• Increasing, constant, and diminishing returns to scale describe how quickly output rises as
inputs increase. Three types of returns to scale and describe how they occur.
• In economics, returns to scale describes what happens when the scale of production
increases over the long run when all input levels are variable (chosen by the firm).
Increasing returns to scale (IRS) refers to a production process where an increase in the
number of units produced causes a decrease in the average cost of each unit.
• Constant returns to scale (CRS) refers to a production process where an increase in the
number of units produced causes no change in the average cost of each unit.
• Diminishing returns to scale (DRS) refers to production where the costs for production do
not decrease as a result of increased production. The DRS is the opposite of the IRS.
• Returns to scale: A term referring to changes in output resulting from a proportional change
in all inputs (where all inputs increase by a constant factor).
• Average cost: In economics, average cost or unit cost is equal to total cost divided by the
number of goods produced.
In Economics, returns to scale describes what happens when the scale of production
increases over the long run when all input levels are variable (chosen by the firm). Returns
to scale explains how the rate of increase in production is related to the increase in inputs in
the long run. There are three stages in the returns to scale: increasing returns to scale (IRS),
constant returns to scale (CRS), and diminishing returns to scale (DRS). Returns to scale
vary between industries, but typically a firm will have increasing returns to scale at low
levels of production, decreasing returns to scale at high levels of production, and constant
returns to scale at some point in the middle.
Long Run ATC Curves: This graph shows that as the output (production) increases, long run
average total cost curve decreases in economies of scale, constant in constant returns to scale, and
increases in diseconomies of scale.
Increasing Returns to Scale: The first stage, increasing returns to scale (IRS) refers to a
production process where an increase in the number of units produced causes a decrease in the
average cost of each unit. In other words, a firm is experiencing IRS when the cost of producing an
additional unit of output decreases as the volume of its production increases. IRS may take place,
for example, if the cost of production of a manufactured good would decrease with the increase in
quantity produced due to the production materials being obtained at a cheaper price.

5. Constant Return to Scale: The second stage, constant returns to scale (CRS) refers to a production
process where an increase in the number of units produced causes no change in the average cost of
each unit. If output changes proportionally with all the inputs, then there are constant returns to
scale.
Diminishing Return to Scale: The final stage, diminishing returns to scale (DRS) refers to
production for which the average costs of output increase as the level of production increases. The
DRS is the opposite of the IRS. DRS might occur if, for example, a furniture company was forced
to import wood from further and further away as its operations increased.
Economic Costs: The economic cost is based on the cost of the alternative chosen and the benefit
that the best alternative would have provided if chosen. Throughout the production of a good or
service, a firm must make decisions based on economic cost. The economic cost of a decision is
based on both the cost of the alternative chosen and the benefit that the best alternative would have
provided if chosen. Economic cost includes opportunity cost when analysing economic decisions.
An example of economic cost would be the cost of attending college. The accounting cost includes
all charges such as tuition, books, food, housing, and other expenditures. The opportunity cost
includes the salary or wage the individual could be earning if he was employed during his college
years instead of being in school. So, the economic cost of college is the accounting cost plus the
opportunity cost.
Components of a firm’s economic costs
• Economic cost takes into account costs attributed to the alternative chosen and costs specific
to the forgone opportunity.
• Components of economic cost include total cost, variable cost, fixed cost, average cost, and
marginal cost.
• Cost curves – a graph of the costs of production as a function of total quantity produced. In a
free market economy, firms use cost curves to find the optimal point of production (to
minimize cost). Maximizing firms use the curves to decide output quantities to achieve
production goals.
• Average cost (AC) – total costs divided by output (AC = TFC/q + TVC/q).
• Marginal cost (MC) – the change in the total cost when the quantity produced changes by
one unit.
• Cost curves – a graph of the costs of production as a function of total quantity produced. In a
free market economy, firms use cost curves to find the optimal point of production (to
minimize cost). Maximizing firms use the curves to decide output quantities to achieve
production goals.
• economic cost: The accounting cost plus opportunity cost.
• cost: A negative consequence or loss that occurs or is required to occur.
• Opportunity cost: The cost of any activity measured in terms of the value of the next best
alternative forgone (that is not chosen).
Components of Economic Costs
Economic cost takes into account costs attributed to the alternative chosen and costs specific to the
forgone opportunity. Before making economic decisions, there are a series of components of
economic costs that a firm will take into consideration. These components include:
• Total cost (TC): total cost equals total fixed cost plus total variable costs (TC = TFC +
TVC).
• Variable cost (VC): the cost paid to the variable input. Inputs include labor, capital,
materials, power, land, and buildings. Variable input is traditionally assumed to be labor.

6. • Total variable cost (TVC): same as variable costs.
• Fixed cost (FC): the costs of the fixed assets (those that do not vary with production).
• Total fixed cost (TFC): same as fixed cost.
• Average cost (AC): total costs divided by output (AC = TFC/q + TVC/q).
• Average fixed cost (AFC): the fixed costs divided by output (AFC = TFC/q). The average
fixed cost function continuously declines as production increases.
• Average variable cost (AVC): variable costs divided by output (AVC = TVC/q). The average
variable cost curve is normally U-shaped. It lies below the average cost curve, starting to the
right of the y axis.
• Marginal cost (MC): the change in the total cost when the quantity produced changes by one
unit.
• Cost curves: a graph of the costs of production as a function of total quantity produced. In a
free market economy, firms use cost curves to find the optimal point of production (to
minimize cost). Maximizing firms use the curves to decide output quantities to achieve
production goals.
Average total cost (ATC) can be found by adding average fixed costs (AFC) and average variable
costs (AVC). The ATC curve is also ‘U’ shaped because it takes its shape from the AVC curve, with
the upturn reflecting the onset of diminishing returns to the variable factor.
Areas for total costs: Total Fixed costs and Total Variable costs are the respective areas under the
Average Fixed and Average Variable cost curves.
Marginal costs: Marginal cost is the cost
of producing one extra unit of output. It can be found by calculating the change in total cost when
output is increased by one unit.
OUTPUT TOTAL COST MARGINAL COST
1 150
2 180 30
3 200 20
4 210 10
5 250 40
6 320 70

7. 7 450 130
8 740 290
It is important to note that marginal cost is derived solely from variable costs, and not fixed costs.
The marginal cost curve falls briefly at first, then rises. Marginal costs are derived from variable
costs and are subject to the principle of variable proportions.
The significance of marginal cost: The marginal cost curve is significant in the theory of the firm
for two reasons: It is the leading cost curve, because changes in total and average costs are derived
from changes in marginal cost. The lowest price a firm is prepared to supply at is the price that just
covers marginal cost. ATC and MC: Average total cost and marginal cost are connected because
they are derived from the same basic numerical cost data. The general rules governing the
relationship are:
1. Marginal cost will always cut average total cost from below.
2. When marginal cost is below average total cost, average total cost will be falling, and when
marginal cost is above average total cost, average total cost will be rising.
3. A firm is most productively efficient at the lowest average total cost, which is also where
average total cost (ATC) = marginal cost (MC).
Marginal costs are derived exclusively from variable costs, and are unaffected by changes in fixed
costs. The MC curve is the gradient of the TC curve, and the positive gradient of the total cost curve
only exists because of a positive variable cost. This is shown below:

8. Sunk costs: Sunk costs are those that cannot be recovered if a firm goes out of business. Examples
of sunk costs include spending on advertising and marketing, specialist machines that have no scrap
value, and stocks which cannot be sold off. Sunk costs are a considerable barrier to entry and exit.