2. Meaning of cost
Types
- Economic Costs
Outlay costOutlay cost – Actual financial expenditure.– Actual financial expenditure.
Opportunity cost, Pecuniary cost, Social (opportunity) costOpportunity cost, Pecuniary cost, Social (opportunity) cost
Explicit costExplicit cost– Direct contractual monetary payments incurred– Direct contractual monetary payments incurred
through market transactions.through market transactions.
Implicit costImplicit cost – Opportunity cost of owners’ own assets.– Opportunity cost of owners’ own assets.
Production cost & Selling costsProduction cost & Selling costs
Real cost & money costReal cost & money cost
Incremental costIncremental cost – Total additional expenditure associated with– Total additional expenditure associated with
the expansion of output.the expansion of output.
Short run costs & long run costsShort run costs & long run costs
- Accounting Costs
Capital costs, Overhead costs (indirect), Direct costs, Period costsCapital costs, Overhead costs (indirect), Direct costs, Period costs
Out-of-pocket cost & Book costsOut-of-pocket cost & Book costs
Replacement cost & Original / Historical costReplacement cost & Original / Historical cost
3. Avoidable & Unavoidable costAvoidable & Unavoidable cost
Direct & Indirect cost ( Traceable / Assignable Cost and Non-Traceable /Direct & Indirect cost ( Traceable / Assignable Cost and Non-Traceable /
non-assignable cost)non-assignable cost)
Present Vs Future costsPresent Vs Future costs
- Engineering Costs
Planning costsPlanning costs
Execution costsExecution costs
Operation costsOperation costs
Short run costs
Fixed cost / Supplementary cost – Costs that are incurred on fixedCosts that are incurred on fixed
factor input. They remain fixed at any level of out put.factor input. They remain fixed at any level of out put.
Variable cost / Prime cost – Cost incurred on the variable factorCost incurred on the variable factor
inputs. They vary directly with the levelinputs. They vary directly with the level of output.of output.
Behavioural Costs
Total cost
Total Fixed cost – TFC remains constant at all levels of output, thusTFC remains constant at all levels of output, thus
independent of output.independent of output.
Total variable cost – TVC varies with the output, thus directlyTVC varies with the output, thus directly
dependent on output.dependent on output.
* TVC initially increases at a decreasing rate, but after a point itTVC initially increases at a decreasing rate, but after a point it
increases at an increasing rate. ( Law of variable proportion)increases at an increasing rate. ( Law of variable proportion)
4. Total cost – TC varies in the same proportion as the TVC
Per unit cost
- Average cost
Average Fixed cost – Per unit fixed cost
* As the output increases the TFC gets spread over a larger output
and hence AFC goes on progressively declining.AFC curve is
rectangular hyperbola. It approaches both the axes
asymptotically I.e., it gets very close to both the axes but never
touches them.
* The product of AFC with the output for any given level of output
at that level always remains same.
Average variable cost – Per unit variable cost
* AVC declines initially, reaches its minimum and then begins to
rise sharply. AVC is slightly U shaped.
Average total cost – Per unit total cost
*If the output of the firm is increased, ATC decreases initially up
to a point, then remains constant for a while & thereafter starts
rising. AC assumes U shape. ( declining phase, constant phase
and rising phase)
5. Marginal cost – MC is the rate of change in the total cost when the
output is increased by one unit. (The cost of producing the last unit)
- In short run MC is independent of FC & is directly related to the VC.
Mc
curve also assumes U shape.
Relationship between marginal cost and average cost
- When AC is falling, MC is also falling and AC>MC i.e., When both MC
and AC are falling, MC curve lies below the AC curve
- At certain stage MC starts rising but AC continues to fall, AC is still
above the MC.
- When AC is minimum, MC=AC i.e., MC intersects AC at its lowest point.
- When both Ac & MC are rising, MC>AC i.e., AC curve lies below MC.
Area underlying the unit costs
- The point on each average cost curve measures the average cost, but the
area underlying them denotes total cost as under.
- Area underlying AFC curve measures the total fixed cost.
- Area underlying AVC curve measures the total variable cost.
- Area underlying MC curve measures the total variable cost.
- Area underlying ATC curve measures the total cost.
6. Long run costs
In the long run, all costs are variable cost. There is no dichotomyIn the long run, all costs are variable cost. There is no dichotomy
of total cost into fixed and variable costs.of total cost into fixed and variable costs.
Long run average cost curve: It is an envelope of various SACs.: It is an envelope of various SACs.
-- Features-- Features
- It is a tangent curve- It is a tangent curve
- It is an envelope curve- It is an envelope curve
- It is a planning curve- It is a planning curve
- It is a minimum cost combination curve- It is a minimum cost combination curve
- It assumes flatter U shape- It assumes flatter U shape
Long run marginal cost curve : It is derived from the slope of: It is derived from the slope of
total cost curve at various points relating to the given outputtotal cost curve at various points relating to the given output
each time. This curve also assumes flatter U shape.each time. This curve also assumes flatter U shape.
Relationship between LAC and LMC
Same as in the case of SAC and SMCSame as in the case of SAC and SMC
7. Long run costs
In the long run, all costs are variable cost. There is no dichotomyIn the long run, all costs are variable cost. There is no dichotomy
of total cost into fixed and variable costs.of total cost into fixed and variable costs.
Long run average cost curve: It is an envelope of various SACs.: It is an envelope of various SACs.
-- Features-- Features
- It is a tangent curve- It is a tangent curve
- It is an envelope curve- It is an envelope curve
- It is a planning curve- It is a planning curve
- It is a minimum cost combination curve- It is a minimum cost combination curve
- It assumes flatter U shape- It assumes flatter U shape
Long run marginal cost curve : It is derived from the slope of: It is derived from the slope of
total cost curve at various points relating to the given outputtotal cost curve at various points relating to the given output
each time. This curve also assumes flatter U shape.each time. This curve also assumes flatter U shape.
Relationship between LAC and LMC
Same as in the case of SAC and SMCSame as in the case of SAC and SMC
