It is used for analyzing the cost of a
project in short and long run.
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)
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
Variable Costs is the rest of total cost, the part that
varies as you produce more or less. It depends
Eg: Increase of output with labour.
Total variable cost (TVC):
All costs associated with the variable
Average variable cost- cost per unit of output:
AVC = TVC/ Output
The sum of total fixed costs and
total variable costs:
TC = TFC +
Average Total Cost
Average total cost per unit of output:
ATC =AFC + AVC
ATC = TC/ Output
The additional cost incurred from
producing an additional unit of output:
MC = ∆ TC
MC = ∆ TVC
Typical Total Cost Curves
TVC,TC is always increasing:
First at a decreasing rate.
Then at an increasing rate
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
is equal to AFC.
Average value will be
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 >
(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.
3.If expected selling price > minimum ATC (which
implies TR > TC):
A profit can be made.
Maximize profit by producing where:
MR = MC
Long Run Costs Curve:
All costs are variable in the long run.
There is only AVC in LR, since all factors
It is also called as Planning Curve or
Envelope or scale curve.
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
Long Run Cost Curve
Economies of scale Diseconomies of scale
M-optimum level of production
Economies of Scale:
Economies of scale are the cost
advantages that a firm obtains due to
expansion. Diseconomies is the opposite.
1. Pecuniary Economies of Scale:
Paying low prices because of buying
in large Quantity.
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.
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.
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…