2. MEANING OF COST
Cost of producing a good is the sum of actual money expenditure on
purchase of inputs and estimated expenditure on inputs supplied by the firm
itself.
Cost = Explicit cost + Implicit Cost
3. Explicit Cost and Implicit Cost
Explicit Cost – The actual money spent by a firm on buying or hiring of factors
of inputs and non-factor inputs is called money cost or explicit cost.
Implicit Cost – It is the estimated value of inputs supplied by the owner of the
firm himself.
4. Cost Function
The functional relationship between output and cost is called Cost Function.
C = 𝒇 𝑸
where C = Cost
f = Function
Q = Units of Output
In short, cost function studies the relationship between the cost of inputs and level
of output.
5. SHORT RUN COSTS
1. Total Cost (TC)
TC = TFC + TVC
2. Average Cost (AC)
AC = AFC + AVC
3. Marginal Cost (MC)
MC = TCn – TCn-1
6. DISTINGUISH BETWEEN FIXED COSTS AND
VARIABLE COSTS
FIXED COSTS (FC)
1. Fc do not increase or decrease with
increase or decrease in level of output.
2. FC are costs of fixed factors which
cannot be changed during short period.
3. FC can never be zero even when
production is stopped.
4. Production may continue even at the
loss of FC during short period.
5. FC curve is parallel to X-axis.
VARIABLE COSTS (VC)
1. VC change with changes in the level of
output.
2. VC are costs of variable factors capable of
being changed during short period.
3. VC is zero when production is stopped.
4. A firm continues production only when VC
are met.
5. VC curve moves up from left to the right.
13. EXPLANATION
In the figure, MC is U-shaped and P1 is the price line under perfect
competition. At price P1 , the price line cuts MC curve at two points – at
Q1
a and Q1
b , i.e., it satisfies profit maximizing condition P =MC at two
places. But total profit at output level of Q1
b is higher. Therefore, at price P1,
the firm produces the amount Q1
b. It means that if price is OP1 , the firm will
supply Q1
b level of output. Similarly if price is OP2, the firm would supply OQ2
level of output and at price OP3, it would supply OQ3 level of output and so
on. We see clearly that all price-output combinations are simply the points
on the rising portion of MC curve. Hence, it is concluded that the rising
portion of MC curve is the supply curve.
