Cost Concepts


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Cost Concepts

  1. 1. Cost Concepts
  2. 2. Cost Concept:  It is used for analyzing the cost of a project in short and long run.
  3. 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. 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. 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. 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. 7. Marginal Costs  The additional cost incurred from producing an additional unit of output: MC = ∆ TC ∆ Output MC = ∆ TVC ∆ Output
  8. 8. Typical Total Cost Curves  TVC,TC is always increasing:  First at a decreasing rate.  Then at an increasing rate
  9. 9. Typical Average & Marginal Cost Curves
  10. 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. 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. 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. 13. Short Run Production Decisions SP SP
  14. 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. 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. 16. Long Run Cost Curve Economies of scale Diseconomies of scale M M-optimum level of production
  17. 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. 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. 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. 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…