The document discusses concepts of cost analysis including short-run cost functions. It provides a table showing the relationship between total fixed cost, total variable cost, total cost, average variable cost, average fixed cost, average cost, and marginal cost at different output levels. It notes that average cost is lowest when marginal cost equals average cost, representing the least cost input combination or optimal level of production. An example table is given showing output levels and total costs, from which the least cost input combination can be identified as the output level where average cost is lowest.

1. COST ANALYSIS – Part II
Lt.Raison Sam Raju
(M.Com, B.Ed., PGDIBO,UGC-NET-JRF,SET)
Assistant Professor in Commerce & Associate NCC Officer
Mar Thoma College, Tiruvalla

2. Rewind & Forward
• Cost
• Concepts of Cost
• Determinants of Cost
• Cost Output Relationship

3. Determinants of Cost
• Cost of production depends on various factors.
• Output Level : TC has direct relation with Output.
• Prices of factors of Production : Direct Relationship
• Productivity of factors of Production : Inverse Relationship
• Technology : Inverse Relationship

4. Cost – Output Relationship / Cost Function
• CF is the Technical Term used to describe cost – output relationship.
• CF helps in determining optimal level of production.
• The two factors that affect CF is Production Function and Price of
inputs.
• PF is the functional relationship with Input & Output.
• CF can be expressed as
TC = f(Q)
• TC= Total Cost, F= function of OR Depends on, Q= Total Output Produced.
• TC and Q are in direct Relationship.
• CF can divided into two : SR CF , LR CF

5. TC, AC & MC
• Total Cost : Actual Money spent in the production of a particular QTY.
• TC = TFC + TVC
• Average Cost : Total Cost / no. of units produced or Cost per unit
• AC = TC
Q
or AC= AFC + AVC
• Marginal Cost : Addition to TC due production of an additional unit.
• MC =
∆𝑇𝐶
∆𝑄
∆𝑇𝐶 = Change in Total Cost ; ∆𝑄 = Change in QTY.
Marginal
Cost
Avg.
Cost
Total
Cost

6. Short Run Cost Function
• Comment the Definition of Short Period.
• The physical capacity of firm is fixed.
• Existing plant & equipment cannot be increased to produce additional
output.
• Fixed inputs cannot be increased in the Short Run
• We can increase output in Short Run, only by changing variable inputs
or using the existing physical capacity more intensively.
• Total Cost in the short run Consists of TFC and TVC
• TFC will be fixed and TVC varies with Output

7. Short Run Cost Function
• TC = TFC + TVC
• TVC = TC – TFC
• TFC = TC – TVC
• TC = TFC when Output is zero
• In short run there will not be any change in TFC.
• Change in TC implies Change in TVC

8. Cost – Output Relationship in Short Run
Q
(OUTPUT)
TFC TVC TC AVC AFC AC MC
1 2 3 4 5 6 7 8
0 240 0 240 - - - -
1 240 120 360 120 240 360 120
2 240 200 440 100 120 220 80
3 240 270 510 90 80 170 70
4 240 320 560 80 60 140 50
5 240 420 660 84 48 132 100
6 240 552 792 92 40 132 132
7 240 720 960 103 34 137 168
Table 4.1

9. Findings from Table 4.1
• Table is prepared on the basis of Law of Variable Proportion.
• TFC remains fixed at 240 at all levels of production.
• TC = TFC when Output is zero.
• TVC varies directly with Output.
• TC varies mainly because of TVC.
• AFC decrease as per the increase in output.
• We can see the operation of increasing and diminishing returns in the AVC
column.
• From 0-4 AVC falls due to IR; From 5-7, AVC begins to rise due to DR.
• Increase in MC is due to increase in AVC
Q TFC TVC TC AVC AFC AC MC
1 2 3 4 5 6 7 8
0 240 0 240 - - - -
1 240 120 360 120 240 360 120
2 240 200 440 100 120 220 80
3 240 270 510 90 80 170 70
4 240 320 560 80 60 140 50
5 240 420 660 84 48 132 100
6 240 552 792 92 40 132 132
7 240 720 960 103 34 137 168

10. Graphical Representation of TFC, TVC & TC
• TFC is a Straight Line parallel to X axis.
• TVC curve is upward rising from origin.
• TC Curve is upward rising from the TFC line.
• Constant Vertical distance between TC
• & TVC is mainly because of FC.

11. Graphical Representation of MC, AC, AVC &AFC
• AFC slopes downwards – Output AFC
• AVC curve slopes downwards and then begins to rise. – Law of Variable
proportion
• AC curve is U shaped - Law of Variable proportion
• AC – falls – Constant – Rise in relation to output

12. Relation between AVC, AC, & AFC
1. If both AFC and AVC falls, AC will also falls.
2. When AFC falls and AVC rises :
AC will fall - Where the drop in AFC is more than
the rise in the AVC.
AC remains Constant if the drop in AFC = rise in AVC.
AC will rise where the drop in AFC is less than the
rise in AVC

13. Relationship between AC and MC curves
• AC is falling when MC is less than AC
• AC is rising when MC is more than AC
• At the point E, MC = AC and MC cuts AC from the below.
• Production of additional output does not changing AC
Q TFC TVC TC AVC AFC AC MC
1 2 3 4 5 6 7 8
0 240 0 240 - - - -
1 240 120 360 120 240 360 120
2 240 200 440 100 120 220 80
3 240 270 510 90 80 170 70
4 240 320 560 80 60 140 50
5 240 420 660 84 48 132 100
6 240 552 792 92 40 132 132
7 240 720 960 103 34 137 168

14. Least Cost Input Combination (Optimum Firm)
• The firm which fully utilises its scale of operations and produces optimum
output with the minimum cost /unit of production.
• The output at the point E, is the least cost input combination.
• MC = AC or Lowest point in the AC curve.
• LCIC is attained when Output reaches 6units.
Q TFC TVC TC AVC AFC AC MC
1 2 3 4 5 6 7 8
0 240 0 240 - - - -
1 240 120 360 120 240 360 120
2 240 200 440 100 120 220 80
3 240 270 510 90 80 170 70
4 240 320 560 80 60 140 50
5 240 420 660 84 48 132 100
6 240 552 792 92 40 132 132
7 240 720 960 103 34 137 168

15. The short run production and cost details are given
below. Find out the LCIC level. what's the principle?
Output TC
1 51
2 62
3 72
4 80
5 90
6 102
7 119
Output TC AC Marginal
Cost
1 51
2 62
3 72
4 80
5 90
6 102
7 119

16. Thank You
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