Class Lecture: Final

Managerial Economics (Econ-5302)

Course instructor: Basharat Hossain
Department of Business Administration (DBA),
International Islamic University Chittagong (IIUC)

Theory of Cost

TC=total cost= C
TC= FC+VC = Fixed cost + variable cost
Fixed cost: cost that occur before starting the production.
Ex: planning , registration, land & building, utility services line/connections,
labor/employees, transport, decoration, machineries,
variable cost: cost that occur after starting the production.
Ex: production cost, rapairing, utility bill, labor,

AC= Average cost:

TC= FC+VC = Fixed cost + variable cost

AC= Average cost: =

AC=Average Fixed cost+ average variable cost

AFC = Average Fixed cost=

AVC=average variable cost=

TC=FC+VC

AC= = =

AC= AFC+AVC
…………………………………………..
( )
MC= Marginal cost: = the change in cost due to the change in additional
( )
amount of output. Q-1, Total cost-10, Q-2, TC=16, MC=6

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 1
 ………………………………………..
TC= 3Q³-100Q²+200Q+500

FC= 500

VC= 3Q³ - 100Q² + 200Q

Find out: AC, AFC, AVC, MC.

AFC= (= =50, =0.00025)

AVC= = 3Q²-100Q+200

AC= = 3Q²-100Q+200+

( ) ( )
MC= ( )
= ( )
=

= 9Q²-200Q+200
Cost

FC=500

VC VC

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 2
 MC
MC
AFC AVC
AC

Q
Q* Q

AVC

AVC

AFC

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 3
 TC

TC

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 4
MINIMUM POINT of AC is the optimal Point for cost minimizing.
…………………………………………………………………………………………………………
Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,
International Islamic University Chittagong, Bangladesh
Page 5
EXAMPLE: Find out the AC minimizing output. And comment on
your result.

TC=

Ans

TC=

AC = = = 3Q²-100Q+200

( )
AC minimizing condition: =…………………….=0
( )

( ) ( )
( ) ( )

= 6Q-100=0

= 6Q=100

Q=

Q*=16.67

Average Cost will be minimized when Q*=16.67.

………………………………………………………………………………….
Home work: TC= . Find out the AC minimizing output

AC = = = 100Q-10+

( ) ( )
( ) ( )
= 100-0+ = 100+ =0…..Q=???

……………………………………………………………………………………..
( ) ( )
Economies of Scope: ( ( )

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 6
 ( ) ( )

or 20% cost reduces

( )

( ( )

Example: book publisher: writer+press+paper; Mobile+operating system

…………………………………………………………………………………………………………
Sunk cost: the cost that cannot be recoverd if spent once.
Incremental cost: additional cost of producing additional amount.
Fabrics . MC=0, then production rises .
……………………………..
Profit contribution= P-AVC=50-35=15
P=price
AVC=average variable cost

Break even output= = =333.33

TR=TC or TR-TC=0; P=AC

Profit Target output= = =3666.67

…………………………………………………………………………………………………………

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 7
…………………………………………………………………………………………………………………………

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 8
 Homework:

P=AC or TR-TC=0

Q=10
P=1000
PROFIT TARGET=100000
Find out the 1) Break even output; 2) Profit Target output

( )
( )

Q=10
P=1000
…………………………………………………………………………………………………………………………

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 9
 Relationship among AC, AVC and MC: Shut down condition:

Business –loss………..shut down? Yes, why? , No, why?

Try to recover. Rethink ,replan, modify, If solved, then recovered.
………….but face loss………….
A= minimum AC and
PRODUCTION continues……….. optimal poit for firm.
To minimize loss by making VC=0 S= Shut down point
Market: dues, loan, employee compensation, Q*= optimal output
TC=FC + VC Qs= Shut down output
TC=FC + 0
TC=FC

AC,MC,AVC AC
MC

AVC

Q
Qs Q*

If , P>A, Profit
P=A, Break even
P<A, Loss
But continue production up to point S to minimize loss.
At point S, production must be stopped.
S= minimum AVC, or AVC = 0.
( )
Shut down condition: =………….=0,
( )
Q=….?

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 10
Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,
International Islamic University Chittagong, Bangladesh
Page 11
Example:

TC= 9Q³-50Q²+500Q+200

Find out the shut down output and shut down price.

Ans
Shut down condition:
( )
=…………………….=0
( )

VC=9Q³-50Q²+500Q

=AVC=9Q²-50Q+500

( ) ( )
= = 18Q-50=0
( ) ( )

18Q = 50

Q=

When QS=2.77, then the firm should shut down its production.
shut down price:
P=MC, at first find out the MC, then put the value of Qs into MC Equation.
TC= 9Q³-50Q²+500Q+200
( )
MC= =27Q²-100Q+500
( )

=27(2.77)²-100*2.77+500
= 430.1683
SO when price= 430.1683, , then the firm should shut down its production.

420<430.1683: already late, he must shut down now.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 12
445>430.1683: he should try to recover by continuing the production.
……………………………………………………………..………………………………………
Short Run and Long Run Average Cost Curves:
Relationship and Difference:

Short Run Average Cost Curve:

In the short run, the shape of the average total cost curve (ATC) is U-shaped. The, short
run average cost curve falls in the beginning, reaches a minimum and then begins to rise.
The reasons for the average cost to fall in the beginning of production are that the fixed
factors of a firm remain the same. The change only takes place in the variable factors such as
raw material, labor, etc.

As the fixed cost gets distributed over the output as production is expanded, the average cost,
therefore, begins to fall. When a firm fully utilizes its scale of operation (plant size), the
average cost is then at its minimum. The firm is then operating to its optimum capacity. If a
firm in the short-run increases its level of output with the same fixed plant; the economies of
that scale of production change into diseconomies and the average cost then begins to rise
sharply.

Long Run Average Cost Curve:

In the long run, all costs of a firm are variable. The factors of production can be used in
varying proportions to deal with an increased output. The firm having time-period long
enough can build larger scale or type of plant to produce the anticipated output. The shape of
the long run average cost curve is also U-shaped but is flatter that the short run curve as is
illustrated in the following diagram:

Diagram/Figure:

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 13
In the diagram 13.7 given above, there are five alternative scales of plant SAC1 SAC2, SAC3,
SAC4 and, SAC5. In the long run, the firm will operate the scale of plant which is most
profitable to it.

For example, if the anticipated rate of output is 200 units per unit of time, the firm will
choose the smallest plant It will build the scale of plant given by SAC1 and operate it at point
A. This is because of the fact that at the output of 200 units, the cost per unit is lowest with
the plant size 1 which is the smallest of all the four plants. In case, the volume of sales
expands to 400, units, the size of the plant will be increased and the desired output will be
attained by the scale of plant represented by SAC2 at point B, If the anticipated output rate is
600 units, the firm will build the size of plant given by SAC3 and operate it at point C where
the average cost is $26 and also the lowest The optimum output of the firm is obtained at
point C on the medium size plant SAC3.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 14