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  1. 1. Costs
  2. 2. <ul><li>The cost function relates cost to output. Underpinning the cost function is the production function -which relates output to productive inputs </li></ul><ul><li>Types of Cost Functions are </li></ul><ul><li>Short Run Cost Functions/used for routine operating decisions. </li></ul><ul><li>Long Run Cost Functions/used for longer term dis/investment decisions </li></ul>
  3. 3. The long-run <ul><li>The long-run is a period long enough for the firm to vary all inputs and be able to alter operational capacity. It must choose the most appropriate type and scale of operation to suit expected demand. </li></ul><ul><li>The long run average cost curve is typically drawn as U-shaped </li></ul>
  4. 4. The Short Run (is a period when at least one input is fixed) <ul><li>The shorter the time period, the greater the quantity of costs that are fixed. Fixed and Variable Costs </li></ul><ul><li>It's important to realize that fixed costs are &quot;fixed&quot; only within a certain range of activity or over a certain period of time. If enough time passes, all costs become variable. </li></ul><ul><li>Fixed costs are expenses whose total does not change in proportion to the activity of a business. (Indirect costs may be fixed or variable.) </li></ul><ul><li>Fixed costs are associated with fixed inputs </li></ul>
  5. 5. <ul><li>Two basic types of cost functions are used in managerial decision-making: </li></ul><ul><ul><li>• (short-run cost functions) are, relevant to day-to-day operating decisions. </li></ul></ul><ul><ul><li>• (long-run cost functions) are used for long-range planning, including investment decision-making. </li></ul></ul>
  6. 6. <ul><li>Variable costs are costs to production which vary according to quantity produced, such as raw materials. Fixed costs are costs which are constant, and can only be eliminated by going out of business </li></ul><ul><li>the total cost describes the total economic cost of production and is made up of variable and fixed costs </li></ul><ul><li>Total Cost (TC) at each level of output (Q) in the short-run is the sum of Total Fixed Cost (TFC), a constant, and Total Variable Cost (TVC). </li></ul><ul><li>TC = TFC + TVC </li></ul>
  7. 7. <ul><li>In analysing cost behaviour, it is useful to not only know total cost, but also average (unit) cost and marginal cost (the cost of providing one extra unit of output). </li></ul><ul><li>Average total cost is the cost of making all of the units divided by the number of units made. </li></ul><ul><li>The Average total cost could also be found by adding the Average variable cost and the Average fixed cost for a unit. </li></ul>
  8. 8. <ul><li>Average Total Costs (AC) is the sum of Average Fixed Cost (AFC) and Average Variable Cost (AVC) </li></ul><ul><li>AC = AFC + AVC </li></ul><ul><li>where AC = TC/Q </li></ul><ul><li>AFC = TFC/Q </li></ul><ul><li>AVC = TVC/Q </li></ul><ul><li>Marginal Cost is the change in total cost for a one unit change in output </li></ul><ul><li>MC = Change in Total Cost over </li></ul><ul><li>Change in Output </li></ul>
  9. 9. Factors Determining the Variability of Short-Run Costs <ul><li>Three major factors influence the behaviour of short-run costs: </li></ul><ul><li>(i) the proportion of fixed costs to total costs </li></ul><ul><li>(ii) flexibility of input proportions in the production process </li></ul><ul><li>(iii) divisibility of fixed inputs at low levels of output </li></ul>