This document is a module on cost analysis from Mr. Anirban of Christ College Institute of Management in Bangalore. It covers various cost concepts including actual and opportunity costs, fixed and variable costs, as well as cost curves like total, average, and marginal costs. Examples are provided to illustrate break-even analysis and the calculation of costs at different output levels. The module aims to explain traditional cost theory and how costs are measured in managerial economics.

1. MANAGERIAL ECONOMICS
MODULE 4
BY
Mr. Anirban
Christ College Institute of
Management
Bangalore
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2. Cost Analysis
 Actual Cost and Opportunity Cost
 Sunk Cost and Outlay Cost (Depreciation)
 Explicit and Implicit Cost
 Imputed Cost
 Incremental Cost and Sunk Cost
 Book Cost and Out of the pocket cost
 Accounting and Economic Cost
 Private and Social Cost
 Direct and Indirect Cost
 Controllable and Original Cost
 Replacement and Original Cost
 Shutdown and Abandonment Cost
 Urgent and Postponable Cost
 Business Cost and Full Cost
 Marginal, Average and Total Cost
 Fixed and Variable Cost
 Short Run and Long run cost
 Incremental and Marginal Cost
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3. Cost Analysis – Traditional Cost Theory
Fixed Costs / Supplementary Cost:
 Fixed Costs are those costs which are
independent of output, i.e. it is the cost
of the fixed inputs, which remain
unchanged what ever the amount of
output produced and includes both
explicit and implicit costs.
 TFC = r k = A (Positive Constant) = f(Q)
 It is also known as Overhead Costs and
is incurred in hiring the fixed factors of
production whose amount can’t be
altered in the short run, so shape of the
TFC curve is parallel to X axis.
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4. Cost Analysis – Traditional Cost Theory
Average Fixed Cost:
 Average Fixed Cost is the total fixed cost divided by the no
of units of the output produced.
 As the Fixed Cost is not directly related with the quantity
produced by the producer, hence per unit average fixed
cost is lower and lower when quantity produced is more
and more.
 As the relation ship between AFC and produced total
quantity is inverse, so the AFC curve is downward sloped.
 TFC = r k = A (Positive Constant) = f(Q)> 0
AFC = TFC / Q = r k / Q = A/Q = f(Q)
 AFC has the following characteristics:
 AFC curve is – vely sloped.
 AFC curve is convex to the origin.
 AFC is monotonically decreasing function of Q, which
means the AFC curve is “asymplatic” to the axis i.e. the
curve is very much closer to the axis but never
intersects.
 All the rectangle drawn below the AFC curve represent
constant AFC or equal areas.
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5. Cost Analysis – Traditional Cost Theory
Total Variable Costs:
 Variable costs are those costs which change of output,
i.e. Variable costs are those costs which are incurred on
the employment of the variable factors of production
whose amount can be altered in the short run.
 Let in the cost function Labour is the only variable input,
So TVC = w L, where
 L = Amount of Labour employed,
 w = Price per unit of Labour (Wage) which is
given so fixed.
 The shape of the TVC curve reflects the “Law of variable
proportion” that more and more output produced, it
increases at a increasing rate, after point of inflection it
increases at a diminishing rate.
 To the shape of the TVC curve is the mirror reflection of
the total product curve, i.e. inverse S shape. (Concave
[Convex] to the Q axis due to increasing [diminishing]
returns and point of Inflection represents Constant
returns.
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6. Cost Analysis – Traditional Cost Theory
Average Variable Cost:
 The TVC For the variable inputs the total cost
borrowed by the producer is called the variable cost.
 Average variable cost is the TVC divided by the no of
units of the output produced.
 TVC = w L, AVC = TVC/Q = w L/Q =
w/(Q/L) = w / APL
 Due to the Law of Variable proportion AP L curve is
inverse U shaped which means AVC curve is U
shaped.
 Which means
 APL (Increasing) AVC (Decreasing)
 APL (Maximum) AVC (Minimum)
 APL (Decreasing) AVC (Increasing)
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7. Cost Analysis – Traditional Cost Theory
Marginal Cost:
 Marginal Cost represents the last unit cost, i.e.
addition to the total cost of production due to
the increase in production by one unit.
 MC = d/dq (TC) = [TC2 – TC1] / [Q2 – Q1]
 If TC2 > TC1 , MC >0
 If TC2 < TC1 , MC <0
 If TC2 = TC1 , MC =0
 Theoretically MC may be positive or negative
but rational production behaviour considering
Positive MC.
Total Cost:
 TC = TFC + TVC
 AC = AFC + AVC
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8. Cost Analysis – Traditional Cost Theory
Problems:
 Obtain the break even level of output x, given
the following information: [Ans: 40000]
Cost Function : C = 200000 + 10x
Revenue Function : R = 15x
 The total cost of production of firm is given by
the following function: [P = 1.72]
C = (5/13)x + 200
If the quantity sold is Rs 150 units, at what
price should the firm sell so as to break even?
 If the Cost function is C(x) = 5x + 350 and
Revenue function is R(x) = 50x – x2, Find the
Break even Values, [10, 35]
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9. Cost Analysis – Traditional Cost Theory
 If the total cost function is written as TC =
1/3X3 – 3X2 + 9X, where X is the output in
thousands units. At what level output, AC is
minimum. [4500 units]
 The total cost of production of a firm is
given by the following function :
C = 5/13 X + 200. Find
a) The total cost on output of 65 units.
b) The AC for an output of 100 units.
c) The marginal cost for an output of 50
units.
d) If the quantity sold is 150units, at what
price should the firm sell so as to
break even? [225, 31/13, 5/13, 67/39]
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10. Cost Analysis – Traditional Cost Theory
 The following information is given below:
Demand Function : P = 12 – 0.4q
Cost Function : C = 5 + 4q + 0.6q2,
Where C denotes the total cost, P is the
price per unit and q is the quantity
produced. Determine P and q in order to
maximize the total profit. [ q = 4 and P =
10.6]
 A firm has the following functions, find the
maximum profit. [Profit = 5000]
Revenue Function (R):R = 100q – q2
Cost Function (C) :C = q3 – 57/2 q2
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