Cost refers to the total expenditure incurred by a producer to produce a given level of output. It includes explicit costs, which are cash payments to factors of production, and implicit costs, which are imputed costs of self-owned resources. Total cost is the sum of fixed costs, which do not vary with output, and variable costs, which do vary with output. Marginal cost is the change in total cost from producing one additional unit of output. It is U-shaped, initially decreasing and then increasing, reflecting the law of variable proportions. Average cost is total cost divided by output and is the sum of average fixed cost and average variable cost.

2. What Is Cost ?
Cost refers to the expenditure incurred
by a producer ( Explicitly or Implicitly )
on the factor as well as non – factor
inputs for a given amount of output of a
commodity .

3. Explicit Cost and Implicit Cost
 In Economics , total cost is estimated considering its two elements , viz. , explicit
cost and implicit cost.
 Total Cost = Explicit Cost + Implicit Cost
 Explicit Cost – Those cash payments which firms makes to the outsiders from their
goods and services . ( Tangible in nature. )
For examples – 1. Procurement of raw material
2. Payment of salary and wages
3. Transportation expenses
4. Rent

4.  Implicit Cost – These are the cost of self owned and self employed in the
process of production . It does not involve any cash payment . ( Intangible in
nature. )
For example – 1. Imputed rent of the building
2. Imputed salaries of the owner
3. Imputed interest on money invested by the owner

6. Opportunity Cost
It refers to the total sacrifice made
( explicits or implicits ) for availing an
opportunity ( or producing a given level
of output ) .

7. Selling Cost And Production
Cost
 Selling Cost – It refers to the expenditure
incurred by the producer to promote sale of
the commodity . Example – expenditure on
advertisement .
 Production Cost – It refers to the
expenditure incurred by a producer
( explicitly or implicitly ) on the inputs for
producing a given level of output .

8. Short Run Costs
 Short run is a period of time during which some factors are fixed and some are
variable .Short run costs have two components , viz. , Fixed costs and Variable costs .
 TC ( Total Cost ) = TFC ( Total Fixed Cost ) + TVC ( Total Variable Cost )
1. Fixed Costs – Fixed costs are the costs related to the use of fixed factors of
production ( land , machine and plant ) .
Schedule :

9. TFC is a horizontal straight line parallel to X – axis , showing
that total fixed cost is constant at all levels of output .

10. 2. Variable costs – Variable costs refer to the expenditure incurred by the
producer on the use of variable factors of production ( raw material , wages of
casual labour , power and fuel ) .
Schedule :

11. TVC increases with increase in output . It is = Rs 10 , when
output = 1 unit , and is = Rs 38 , when output = 6 units .
Between 0-A , TVC increases at a decreasing rate . Beyond
point A , TVC increases at an increasing rate .

12. CONTRAST
Fixed Costs
 Fixed costs do not change with
change in quantity of output .
 They remain the same whether
output is zero or maximum .
 Examples : rent , wages of
permanent staff , license fee , cost
of plant and machinery .
Variable Costs
 Variable costs change with change
in quantity of output .
 They are zero when output is zero.
These costs increase when output
increases and decrease when
output decreases .
 Examples : cost of raw material ,
wages of casual labour , expenses
on electricity .

13. Behaviour Of Fixed Cost , Variable
Cost and Total Cost
Schedule :

14.  TFC is constant at all levels of output .
 TVC increases as output increases .
 TC is parallel to TVC . It shows that the difference between
TC and TVC ( = TFC ) is constant .

15.  Average Cost – It is the cost per unit of output produced .
 AC = TC / Q
 AC = Average Cost , TC = Total Cost , Q = Quantity of output
 AC = AFC + AVC
Schedule :

16.  Average Fixed Cost : It is the fixed cost per unit of output .
 AFC = TFC / Q
Schedule :

17. AFC Curve is rectangular hyperbola . If we take any point on AFC curve and multiply AFC at that
point with the corresponding level of output , the product shall always be the same . This shows
that total fixed cost remains constant at all levels of output .
1. AFC decreases as output increases .
2. AFC x Q at any level of output is the same . Because ,
AFC x Q = TFC
which is constant at all levels of output .
Thus : 4 x 2.5 = 10
8 x 1.25 = 10

18.  Average Variable Cost – It is the variable cost per unit of output .
 AVC = TVC / Q
Schedule :

19. AVC curve is U – shaped . This is in accordance with the
law of variable proportions . It falls so long as returns to a
factor are increasing . It rises when returns to a factor are
decreasing .

20. AC as the Summation of AFC and AVC

23.  Marginal Cost – It is the change in total cost when an additional unit
of output is produced .
 MCn = TCn – TCn-1
Schedule :

24. MC is U – shaped in accordance with the law of variable proportions .
Initially , MC is falling . It is because MP tends to rise when there are
increasing returns to a factor .subsequently , MC tends to rise . It is
because MP tends to fall when there are diminishing returns to a
factor .

25.  The sum total of marginal cost corresponding to different units of output is
TVC .
 ∑MC = TVC
 At OL level of output , area under MC Curve = OLSK .
 This is equal to TVC .
 This is because TVC = ∑MC . Total variable cost is the sum
total of marginal cost for each unit of a given output .

26. Relation between Average Cost and
Marginal Cost
Output
( units )
Total Cost
( Rs )
Average Cost
AC = TC/Q
( Rs )
Marginal Cost
MC = TCn – TCn-1
( Rs )
0 10 ∞ -
1 20 20 10
2 28 14 8
3 34 11.3 6
4 38 9.5 4
5 42 8.4 4
6 48 8 6
7 56 8 8
8 72 9 16

27.  When AC is falling , MC < AC .
 When AC is rising , MC > AC .
 When AC is constant ( as at point E ) , MC = AC .
 MC is always to the left of AC and cuts AC from its lowest point .

28. Relation between AVC and MC
 When AVC falls , MC <
AVC .
 When AVC rises , MC
> AVC .
 When AVC is constant
, MC =AVC ( it is the
lowest point of AVC ) .

29. Relation between Total Cost and
Marginal Cost
 Up to point Q* , TC is
increasing at a decreasing
rate , because MC is
decreasing .
 Beyond point Q* , TC is
increasing at an increasing
rate , because MC is
increasing .
 At point Q* , TC stops
increasing at a decreasing
rate , because MC touches its
lowest point .

30. AC , AVC , AFC and MC in one Diagram
 When AC declines , MC
declines faster than AC .
So that MC curve
remains below AC curve
.
 When AC increases , MC
increases faster than AC
. So that MC curve is
above AC curve .
 Since MC declines faster
than AC , it reaches its
lowest point earlier than
AC . So that MC starts
rising even when AC is
falling .
 MC must cut AC from its
lowest point .

31. LIST OF FORMULAE
 Cost = Explicit Cost + Implicit Cost
 TC = TFC + TVC
 AC = AFC + AVC
 AC=TC/Q => AC x Q = TC
 AFC = TFC/Q => AFC x Q = TFC
 AVC = TVC/Q => AVC x Q = TVC
 MC = TVCn – TVCn-1
 ∑MC = TVC

32. Short Questions
Q 1 . What does cost mean in Economics ?
Ans. Cost is the expenditure incurred by the producer ( explicitly and implicitly )
on factor as well as non – factor inputs for a given amount of output of a
commodity .
Q 2 . What is meant by explicit and implicit costs ?
Ans. Explicit costs are those cash payments which a firm makes to others for the
purchase of inputs .
Implicit costs are imputed ( estimated ) costs of self – owned and self –
employed resources .
Q 3 . Define opportunity cost ?
Ans. It is the total sacrifice made for availing an opportunity or producing a given
level of output .
Q 4 . What are selling costs ?
Ans. Selling costs refer to the expenditure incurred by the producer in order to
promote the sale of the commodity .

33. Q 5 . Define production cost .
Ans. Production cost refers to the expenditure incurred by the producer on the
inputs for producing a given level of output .
Q 6 . What is meant by fixed cost ?
Ans. It is the cost incurred on the purchase of fixed inputs of production , like
plant and machinery .
Q 7 . What is meant by variable cost ?
Ans. It is the cost incurred on the purchase of variable inputs of production , like
raw material .
Q 8 . Define total cost .
Ans. It refers to all expenses incurred by the producer to produce a given
quantity of output .
Q 9 . The cost of zero level of output is equal to which cost ?
Ans. It is equal to fixed cost .
Q 10 . Why is total fixed cost curve parallel to X-axis ?
Ans. It is because total fixed cost remains constant at all levels of output .
Q 11 . What is the general shape of MC curve ?
Ans. ‘U’ shaped .

34. Q 12 . If the total cost of producing 5 units of a commodity is Rs 20 and that of producing
4 units is Rs 15 , what will be the marginal cost ?
Ans. MC = TCn – TCn-1
= Rs 20 – Rs 15
= Rs 5
Q 13 . Find out TC , given the following information on MC for a firm which has spent Rs
50 thousand on its establishment even when output was zero ?
Output
(Units)
1 2 3 4 5 6 7
MC (Rs
thousand )
7 6 5 4 3 2 1

35. Output (units) MC TVC TC = TFC + TVC ( TFC =
Rs 50 thousand )
1 7 7 50 + 7 = 57
2 6 13 50 + 13 = 63
3 5 18 50 + 18 = 68
4 4 22 50 + 22 = 72
5 3 25 50 + 25 = 75
6 2 27 50 + 27 = 77
7 1 28 50 + 28 = 78
Ans.

36. MADE BY SANJANA IN THE GUIDANCE OF MRS.
VIDYUT SHIKHA MAM .
CLASS – XII - C