CHAPTER-4

Cost Concepts and Cost-Output Analysis

Course Content
Cost concepts: economic, explicit and implicit costs
Direct and indirect costs
Opportunity cost
Historical and replacement costs
Private and social costs
Incremental and sunk cost
Total cost, fixed cost and variable cost, average costs
Separable and common costs
Relationship of MC and AVC, ATC and AFC
Long-run and short-run costs
Cost function
Economics of scale
Concept of production and revenue
Returns to scale
An application of cost analysis
Estimation of cost function
Difficulties in empirical determination of cost functions
Cost Concepts
Cost is related to the financial aspect of production. It is the amount paid for services of
factors of production. When a firm produces goods and services, it has to make input
payments to laborers, land-owners, capitalist, raw materials and fuel suppliers etc. The
value of inputs needed to produce any goods or service that has to be measured in terms of
some units usually money. The sum total of these expenses makes up total cost of
production. In other words, total cost of production is the sum of all inputs costs incurred
in the production process. The cost of production varies with the quantity of output
produced. Hence the amount of money paid for a thing is called cost or cost is the amount
of expenditure incurred for a given things i.e. goods or services.
Economic Costs: Economic costs refer to the total cost. It includes all explicit cost, implicit cost
as well as opportunity cost.
Economic cost is much wider concept. It is important for economists in determining the
level of production and profit minimization. It is designed to provide decision-making
guideline for management to achieve the goals of the firm. The various costs like- total
cost, average cost, marginal cost, short-run and long-run costs are based on a view of cost
problem from an economic point of view. Entrepreneurs who invest resources and ability
should get reward at least that much he could earn elsewhere. Hence, economic cost is a
summation of explicit (accounting) cost and implicit cost. In other words, economic cost
is the sum of the cost of market purchased resources and owner-firm supplied resources of
production.

Explicit Cost and Implicit Cost (imputed costs)

Explicit Cost: Explicit costs are direct and contractual monetary payments by the producer so
that it incurred through market transactions like - cost of raw materials, wages & salaries,
power charges, rent of business & factory premises, interest payments on capital, insurance
premium, taxes paid, marketing & advertising expenses. It is also known as accounting cost
since it appears in the accounting records of the business company.
Explicit costs also known as out-of-pocket costs due to they are the cost paid to hired or
purchased factors of production. In producing goods and providing services a firm or
company has to hire different factors of production from outside the firm (i.e. from the
market). Major categories of such factors are land, labor, capital, raw materials, power, fuel
etc. Therefore the expenses incurred while purchasing or hiring such payments go out of
the firm's premises. For discussion; you can think the costs of college where you are
studying. What are the factors purchased or hired by your college from the market and
what amount of money does it pay for them?

Implicit Costs: Implicit costs are the opportunity costs for the use of owner's factors which does
not buy or hire but already owns. It refers to the wages, rent, interest etc. due to the
entrepreneur self employing his own resources in business. It is necessary to take into
account both explicit and implicit costs for economic decision making.
Implicit costs are the imputed value of the entrepreneur's own resources. It includes self-
owned resources and self-employment implicit wage, implicit interest and implicit rent. It
is the receipts of the entrepreneur's own resources used in his own business. Value is
imputed from the best alternatives use of the inputs. Implicit costs are input costs that do
not require an expenditure of money by the firm. In economics, an implicit cost in relation
to a business firm includes costs when it foregone an alternative action but doesn't make a
physical payment. Such costs are related to forgone benefits of any single transaction and
occur when a firm:
 Use its own capital
 Uses its owner's time and financial resources.
A firm using its own capital is considered to have been bearing an implicit cost because the
firm could receive rent of capital to another firm. Such costs are often referred to as an
opportunity cost. This rental income foregone is the firm's opportunity cost of using its own
capital, which is also referred to as the implicit rental rate of capital. For discussion: think
 over the time and resources devoted by the owner-promoter of your college. Should they
get some reward for this?
Direct Cost
 It is those costs which can be reasonably measured and allocated with specific output
or work activity.
 The labor and material costs directly associated with a product or service or a
construction activity are direct costs.
 It is also known as prime cost.
Indirect and Overhead Cost
 It consist all costs other than direct material and direct labor.
 It is the sum of indirect material cost, indirect labor cost and all other indirect
expenses.
 The term overhead cost is used to mean all expenditures that are not direct costs.
 Indirect costs are those that can't be reasonably measured and allocated to a specific
output or work activity.
 Overhead cost may be four types– production overhead, administrative overhead,
selling overhead and distribution overhead.

Direct Cost Items Examples

Direct Material Milk for curd, Cloth in a shirt, Paper in book, Wood in a chair etc.
Direct Labor Salary of manager, Salary of driver and other staffs etc.
Direct Expenses Cost of design and drawing, Registration fee, Hire of Special tools,
Tax, Depreciation, Insurance etc.

Indirect Cost Examples

Items
Indirect Material Fuel, lubricants, small tools, glue in a book, thread in a shirt etc.
Indirect Labor Overtime pay, holiday pay, maintenance charge etc.
Indirect Expenses Stationary, electric, water, training, medicine etc.

Opportunity Cost
 It is the cost for best rejected/foregoing opportunity to earn return from the use of
resources.
 It is hidden or expected cost but important for decision making process.
 Opportunity cost is appeared due to possibility of alternative use of scarce resources.
 It is the value of second best opportunity which is foregone by deciding to do one
thing rather than another.
 It is more useful in business decision.
 If the asset/resource has been abandoned, then the opportunity cost will be zero.

Opportunity costs are alternative costs or return from the next best alternative by the use of same
resources. For example- suppose a businessman can buy a lathe machine or a paper pressing
machine with the help of limited money which can earn him Rs. 50,000 and Rs. 70,000. If he
chooses the pressing machine he would have foregone the opportunity of earning Rs. 50,000.
Thus, his opportunity cost is Rs. 50,000. It is technically the cost of foregone opportunities.

Opportunity cost also termed alternative cost measures in terms of the forgone benefits from the
next best alternatives use of a given resources. The opportunity cost or alternative cost of one
unit of product A is the amount of product B that has been sacrificed by allocating the resources
to produce A rather than B.

Historical and Replacement Cost

Historical cost of an asset states the cost of plant, equipment and material at the price paid
originally for them. Similarly, replacement cost states the cost that the firm would have to incur
if wants to replace or acquire the same assets now. For example, if the price of bronze at the time
of purchase in 2015 was Rs.150 per kg. And if the present price is Rs.180 per kg, the original
cost of Rs.150 is the historical cost and Rs.180 is the replacement cost. Replacement cost means
the price that would have to be paid currently for acquiring the same thing.

Historical cost represents actual cash expenditure and this is what accountants' record and
measure. This means measuring costs in historical terms, at the time they were incurred.
Although this is relevant for tax purpose it may not reflect the current costs. So we have to
consider another variety of cost which is the replacement cost.

Current cost represents the amount that would be paid for an item under present market
conditions. Often current cost exceeds historical costs, particularly because of inflation. In some
conditions like information technology (IT) equipment, current costs tend to be below historical
costs because of rapid improvements in technology.

Private and Social Cost

Private Costs
It is the cost for a producer (business man) to produce goods or service or an activity that
includes the cost or payments to purchase capital equipment, hire labor and buy materials
or other necessary inputs. While this is straightforward from the business side, it also
looks an important issue from the consumers’ perspective. Construction Economics
provides an example of the private cost as a consumer faces when construction own
house.
The private costs of this (building a house) include the labor cost, material cost, design
and drawing charges, maintenance, depreciation and even taxes.
Private costs are paid by the firm or consumer and must be included in production and
consumption decisions.
Social Cost

Social costs include both the private costs and any other external costs to society arising
from the production or consumption of a good or service. Social costs will differ from
private costs. For example, if a producer can avoid the cost of air pollution control
equipment allowing the firm’s production to imposes costs (health or environmental
 degradation) on other parties that are adversely affected by the air pollution. Remember
too, it is not just producers that may impose external costs on society.

The social costs include all these private costs (fuel, oil, maintenance, insurance,
depreciation, and operator’s driving time) and also the cost experienced by people other
than the operator who are exposed to the congestion and air pollution resulting from the
use of the car. It is that even if a firm or individual avoids paying for the external costs
arising from their actions, the costs to society as a whole (congestion, pollution,
environmental clean-up, visual degradation, wildlife impacts, etc.) remain. Those external
costs must be included in the social costs to ensure that society operates at a socially
efficient rate of output.

Marginal cost (MC) or Incremental cost

• The change in total cost due to change in one unit of extra output.
• It is the incremental (additional) cost required to increase in the quantity of output by one
unit.
• It is also referred to as marginal cost (MC).
• MC = TCn – TCn – 1
[TCn = Total Cost up to last (nth) unit of output]
• MC = = dTC/dQ
(where, TC = Total cost, Q = Output quantity &  = Change)

Sunk cost
• All the past (previous) costs which cannot be recovered when a firm leaves from an
industry.
• Sunk costs have no relevance to decision making in future.
• Cost of engineering design, wages, registration, license, decoration, depreciation etc. are
the examples of sunk cost.
Total cost
• The sum of fixed costs and variable costs.
• It is also called sum cost.
Fixed cost
• Those costs which are associated with fixed factors of production like land, plant, building,
equipment etc.
• It remains constant in the production process for certain level of output capacity.
Variable cost
• Those cost which are associated with variable factors of production and vary with change
in level of output like labour, raw materials, fuel etc.
• The difference between fixed cost and variable cost may be found in only short–run
production process.
Average cost
• It is per unit cost of any output level.
• AC =

Separable cost and Common cost

Cost of production can also be classified on the basis of product tractability or detect ability.
Costs that can be easily attributed to specific product or division is called separable cost but the
cost that cannot be identified with a particular product is called common cost. By definition, joint
products incur common costs until they reach the spilt-off point. A spilt-off point is a stage in
production after which the joint products gets separable identities. Costs incurred prior to this
point are called common costs, and any cost incurred after this point is called separable costs.

Common costs or joint costs are costs which cannot be readily identified with individual
products.

For example: a farmer maintains herd of cows and the cows are milked and then the milk again
process / separates into skim, butter, cheese and cream with various products characterized by
the amount of milk fat. In this case, the cost up to purchase and rearing herd of cows for milk is
called common cost. Similarly, the separating the milk into skim, butter, cheese and cream by
further processing is called separable costs.

CONCEPT OF AVERAGE AND MARGINAL COST

The short-run average cost is the ratio between total cost and total quantity produced in a specific
period of time. It is statistical a nature rather than being an actual cost. The average cost is
obtained simply by dividing the total cost (TC) by the total output (Q). It can be expressed as,
(i) Average Fixed Cost (AFC)
Average fixed cost is the per unit fixed cost and which can be obtained by dividing total fixed
cost by the unit of output.
TFC
AFC = Q Where, AFC refers average fixed cost TFC for total fixed cost and Q for quantity output .

(ii) Average Variable Cost (AVC)

Average variable cost is per unit variable cost and which can be obtained by dividing total
variable cost by the unit of output.
TVC
AVC = Q Where, AVC = Average variable cost, TVC = Total variable cost and Q for quantity
output.

(iii) Average Total Cost (ATC) or Average cost (AC)

Average total cost is the per unit total cost and which can be obtained by dividing total cost by
the unit of all factors.
TC TFC+TVC
ATC = Q or, ATC= Q { because TC = TFC+ TVC}
or, ATC = AFC +AVC Where, AFC = Average fixed cost TFC = Total fixed cost and Q for quantity output.

SHORT-RUN MARGINAL COST (SMC)

Short-run marginal cost is defined as additional cost in total cost, when a producer or any
business organization produces one extra more unit of output. Marginal cost is also known as
difference between two successive total cost i.e.
MC = TCn- TCn-1
Where TCn is the total cost, n units of output are produced. And TCn-1 is the total cost when n-1 units are produced.

In other hand marginal cost can be defined as ratio between small change in total cost and small
change in output. In equation form, the concept of marginal cost can be expressed as,
ΔTC
MC = ΔQ
Where, TC = Change in total cost
Q = Change in quantity output.
Δ(TFC+TVC )
or, MC= ΔQ
ΔTFC ΔTVC
+
or, MC= ΔQ ΔQ
ΔTC
∴ MC = ΔQ

Relationship of TFC, TVC, TC, AFC, AVC, AC and MC

Aggregate costs (in Rs.) Average and marginal cost *(in Rs.)
Unit of TFC TVC TC = TFC+TVC AFC = AVC = AC = MC =
Production TFC TVC TC ΔTC
Q Q Q ΔQ
1 50 30 80 50 30 80 80
2 50 50 100 25 25 50 20
3 50 60 110 17 20 37 10
4 50 65 115 12 16 29 5
5 50 75 125 10 15 25 10
6 50 100 150 8 17 25 25
7 50 145 195 7 21 28 45
,
8 50 225 275 6 28 34 80

In the table, average fixed cost decreases throughout the production process because TFC
remains constants whatever be the level of production. But Average variable cost first decreases
and then increases because of increasing and diminishing returns to scale respectively.
Similarly, average cost (AC) first decreases till the production of 5 th units of goods because of
increasing returns to scale of variable inputs and it starts to rise beyond the production of 6 th units
of output because of diminishing returns.
Similarly, marginal cost decreases till the production of 4th number of output and then it begins to
rise at an increasing rate beyond the production of 4th number of output.

RELATION BETWEEN AVERAGE COST AND MARGINAL COST CURVES

There is close relationship between AC and MC. The relation between AC and MC can be
summarized on the following.
(i) When MC falls, AC also falls. But the rate of fall in MC is faster than that of AC. So, MC
curve lies below the AC curve, MC pulls the AC downwards, when MC is above the AC,
then it pulls the AC upward.
(ii) When MC increases, AC also increases but the increasing rate of MC is more than AC.
(iii) MC always intersects AC at the minimum point of AC. The reason for this is that
when MC decreases it pulls AC down and when MC increases it pushes AC up. When
AC becomes constant then AC just equal to MC.
Diagrammatical presentation of AC and MC relationship

MC
AC
Y

O X
Output

Reasons for Declining AC and MC

i) Better utilization of fixed factor of production
ii) Improvement in the scale and the productivity of variable factors.
iii) Reduction in wastage of raw material.
iv) Good management and improvement of efficiency of factors of production.
Reasons for Rising AC and MC
i) Over utilization of fixed factor and plenty of variable factors. In comparison to fixed factors
ii) Wastage of raw materials.
iii) Lack of good management.
iv) Increasing possibility of frequent break down of machinery equipment.
v) Reduction on labour productivity.

LONG-RUN AVERAGE COST CURVE (LAC)

The long -run average cost curve is derived from short-run average cost curves. Each point of
LAC corresponds to a point on short-run cost curves, which tangent We can examine in detail,
how the LAC is derived from the short run cost curves.
Diagrammatical presentation of LAC.
Figure 5.7 : Long-run average cost curve

Y SAC1 SAC5 LAC

SAC4
SAC2

SAC3

O X
Output
The LAC curve does not touch the minimum point of all the SAC as shown in the figure. It
means LAC does not tangent at the minimum points of the entire short run average cost curve.
When the LAC declines then it tangents to the falling portion of the SAC. At the lowest point of
LAC, it only tangents at the minimum point of the SAC which is shown by the point 'T' in the
figure, where, the lowest point of the LAC tangents to the lowest point of SAC 3. When the LAC
is rising beyond the point 'T' it tangents to the rising part of SAC 4 and SAC5. The shape of LAC
is also U shaped but flatter than SACs.

Short run and Long run cost

Short-run is a period of time in which the output can be increase or decrease by changing only
the amount of variable factors such as labour, raw material, chemicals etc. In the short-run the
firm cannot build a new plant or abandon an old one. If the firm wants to increase output in the
short-run, it can only do so by using more labour and more raw materials. It cannot increase
output in the short-run by expanding the capacity.

Long-run, on other hand, is defined as the period of time in which the quantities of all factors
may be varied. All factors being variable in the long-run, the fixed and variable factors
dichotomy holds good only in the short-run. In other words it is that time-span in which all
adjustments and changes are possible to realize.
What do you understand by cost function?

Cost function expresses a relation between cost and output. This means to say that cost functions
depends on the fundamental production function and input prices. A production function
specifies the technical relation between inputs and output, when we combine the production
function with the input prices; it determines the cost function for a business unit that produces
goods and services.
Hence, cost function is derived function from production function and input prices. It is a
relation between cost of production and various determinants of costs. Cost function can be
expressed mathematically as cost;
C = f ( Q, S, T, P ) where, C = cost; Q = output; S = size of plant; T = time/techno; P = factor prices

A mathematical formula used to predict the cost associated with a certain action or a certain level
of output is termed as cost function. Businesses use cost functions to forecast the expenses
associated with production, in order to determine what pricing strategies to use in order to
achieve desired profit margins.

Economies of Scale

Do you think that expansion of output helps to reduce average cost of production? The answer to
this question is provided by the concept of economics of scale.
Economics of scale is defined as the reduction in per unit cost of production with the
expansion of output. In other words, economics of scale are the cost advantages that arise with
increase output of a product.
Economics of scale happens because of the inverse relationship between the quantity produced
and per-unit fixed costs so that greater the quantity of a good produce, lower will be per unit
fixed cost because these costs are shared over a larger number of goods. Economics of scale may
also happens due to reduce variable costs per unit because of operational efficiencies and
cooperation and collaboration (working together) of all involved in the operation of a firm.
The main economies of scale are summarized on following points.
(i) Production Economies
Production economies are appeared due to following factors:
(a) Specialization of labour and indivisibility of capital.
(b) Decrease in set up cost.
(c) Initial fixed cost–such as cost for research & improvement do not increases as increases
production.
(ii) Marketing or Selling Economies
The marketing or selling economies is mainly related with the distribution of product, which
includes following factors:
 (a) Advertising economies; when output increases the average advertising cost decreases and
regular advertisement also gets discount as a result cost of production declines.
(b) Selling activities economies; cost of sales man, sample distribution cost, transportation
cost etc. are decreases as increases sales of production.
(iii) Managerial Economies
When production increases then managerial expenses decreases due to following reasons:
(a) Specialization of management
(b) Increase in managerial efficiency due to fast decision making process or power.
(iv)Financial Economies
When a firm or an industry operates with large scale then different discounts are given to the
organization, so cost starts to decline as an increases output. The financial economies appear
due to following discount.
(a) Discount given in the price of raw materials,
(b) High-discount for large scale advertisements and discount in storage cost,
(c) Discount on transport cost, transportation rates are often lower, if the amount of
commodities transported is large. Due to these various reasons LAC decreases from left
to right.
CONCEPT OF PRODUCTION
In general, production is taken to mean the creation or making of something or creation of utility
in goods and services. It is not only the creation of utility but creation (or addition) of value also.
Hence, production, in economics refers to an activity by which resources are transformed into
different and more useful forms with value added.
Production analysis deals with the general relationship between output of goods and services
with the use of factor inputs. In the theory of production, we shall confine to the introduction of
production function, law of production, and rules /methods of production optimization.
(i) Total Product (TP)
The sum total quantity of a commodity produced by a firm from the use of a given factor
inputs in a certain time period is known as total product or total physical production (TP). In
other words, total product refers to the total number of units produced by both fixed and
variable factors. Therefore, total production in the short period is the function of fixed
factors.
TP = f(QF) Where, TP = Total production Q = Quantity of factors f = Functional relationship
F

(ii)Average Product (AP)

It is output per unit of a factor used. The total output of a good divided by the total quantity
of a factor or input used given in an average product or average physical product.
TP
AP = Q
(iii) Marginal Product (MP)
 Marginal product is the change in total output when change in factor used.
ΔTP
Thus, MP = ΔQ Where, Q is the increase in total factor and TP is the change in total output.

CONCEPT OF REVENUE
The amount of income which is received by a firm or any producer or seller by selling certain
amount of goods and services in a market with in a specific period of time is define as Revenue.
The amount of Revenue depends on quantity of sale and price of goods. The concept of revenue
is discussed under Three parts
Total Revenue (TR)
The total amount of money received by producers or firms by selling certain amount of goods is
said to be total revenue or it is also known as total sales value received by the seller or producer
selling a certain amount of product. The total revenue is obtained by multiplying price per unit of
a commodity by the total amount of quantity sold. Hence, it is expressed in equation Form as
TR = P  Q Where, TR = total revenue P = price per unit of commodity Q = quantity sold
Average Revenue (AR)
The average revenue is defined as the ratio between total revenue and total quantity sold at a
specific period of time. It is obtained by dividing total revenue by the total quantity sod in a
market at a particular unit of time. Hence, it is expressed as,
TR
AR = Q Where, TR = Total Revenue Q = Total quantity sold

In economic sense, average revenue is also known as price per unit of a commodity. If different
units are sold at the different price, then the average revenue and price are equal. But, if different
units are sold at different prices, the average revenue and prices are not the same.
Marginal Revenue (MR)
The marginal revenue is defined as the additional revenue while a producer or seller is able to
gain after selling one extra more unit of goods in the market. It is also known as the change in
total revenue with the change in one unit of output. Therefore it is also said as ratio between
change in total revenue and total quantity sold. In equation from, it can be written as
ΔTR
MR = ΔQ Where, TR = change in total revenue Q = change in quantity sold

LAWS OF RETURNS TO SCALE

The responsiveness of output to a proportionate change in quantity of all inputs is called returns
to scale. When the same proportion increases all inputs, there may three possibilities viz.
(i) Constant returns to scale (ii) increasing returns to scale and (iii) decreasing returns to scale.

Constant Returns to Scale

In this case, when all inputs are increased in given proportion, the output would also increase in
the same proportion. For example, if quantity of labour and capital is increased by 10 percent,
output also increases by 10 percent. If labour and capital are doubled, output also double and
vice versa.
The following figures illustrate that equal increase in inputs is attend by equal increase in output.

Figure A
Y
R
C
3K
B IQ3=30
2K
A
K IQ2=20

O IQ1=10
X
L 2L 3L Labour
Y
Output

30

20

10

O X
K/L 2K/2L 3K/3L
Capital/Labour
Figure B

Increasing Returns to Scale

In the case of increasing returns to scale, when all factors are increased in a given proportion,
output increases by greater proportion. For example, if the amount of labour and capital are
increased by 10 percent, output increases more than 10 percent. If the quantity of labour and
capital doubles output increases more than double.

Figure 4.16 : Increasing Returns to Scale

 Y (A)

R
C
3K B
2K
A
K IQ3=90
IQ2=40
IQ1=10
O X
L 2L 3L Labour
Y
Output
90
80
70
60
50
40
30
20
10
O K/L 2K/2L 3K/3L X
Capital/Labour
(B)

In figure panel (B) shows the input-output relation. The figure shows that the output line slopes
upward. It shows the increasing returns to scale. It is evident from the output line proportionate
increases in the use of labour and capital result in more than a proportionate increase in output.
Decreasing Returns to Scale
In the case of decreasing returns to scale, output increases in a smaller proportion than the
increment in inputs.
For example, if inputs are increased by 10 percent, output increases less than 10 percent. If
inputs doubles, output will less than double.

An application of cost analysis

1- Price determination
2- To find actual profit or loss
3- Use/ selection of production technique (labor intensive or capital intensive)
4- To make factor combination
5- Financial management
6- Selection of project under budget limitation
7- Decision for product expansion
8- Decision for the stock of resources and product etc.
9- Determination of optimum plant size (optimum plant size refers minimum costs per unit of output.)
10- Determination of firms supply curve.
Estimation of cost function

Cost function expresses the relationship between cost and its determinants such as the size of
plant, level of output, input prices, technology, managerial efficiency, etc.
In a mathematical form, it can be expressed as, 
C = f (S, O, P, T, E…..) 
Where, C = cost (total cost) S = plant size O = output level
P = prices of inputs T = time/nature of technology E = managerial efficiency

Engineering method of cost estimation is based directly on the physical relationship of inputs to
output, and uses the price of inputs to determine costs. Estimating cost function rests clearly on
the knowledge on:
(a) production function and (b) price of inputs.

Estimation of production function focus for a given level of production and input prices that
could make optimum input combination for a given output level can be determined. The resultant
cost curve can then be formulated by multiplying each input in the least cost combination by its
supply price to develop the cost function. This method is called engineering method as the
estimates of least cost combinations are provided by engineers. The assumption made while
using this method is that both the technology and factor prices are constant. This method may not
always give the correct estimate of costs as the technology and factor prices do change over a
period of time. Therefore, this method is more relevant for the short run rather than long run.

Difficulties in empirical determination of cost function

1- Problems in implicit cost (opportunity cost) accounting

2- Change in production technology
3- Change in factor market scenario/competition
4- Change in government policy/ tax rates/ subsidy
5- Estimation of economics of scale
6- Political and natural disturbances
7- Change in foreign exchange rate
8- Pressure of labor union etc.
Example;

The short-run total cost is; TC = 200 + 5Q – 0.04Q2 + 0.001Q3 and Q = 10.
Find; (i)Total fixed cost (TFC) (ii) Total variable cost (TVC) (iii) Total cost (TC)
(iv) Average variable cost (AVC) (v) Average fixed cost (AFC) (vi) Marginal cost (MC).

Solution:
Given cost function is: TC = 200 + 5Q – 0.04Q2 + 0.001Q3 and Q = 10
(i) Total Fixed Cost
The cost which is independent of output is called fixed cost, so when the production is zero
(Q = 0) then the variable cost will be also zero, and total fixed cost will be: TFC = 200.
(ii) Total Variable Cost
TVC = 5Q – 0.04Q2 + 0.001Q3 = 5(10) – 0.04(10)2 + 0.001 (10)3 = 50 – 4 + 1 = 47
(iii)Total Cost
If, Q = 10;
TC = 200 + 5(10) – 0.04(10)2 + 0.001 (10)3
TC = 200 + 50 – 4 + 1
TC = 247 (Here, TC = TFC + TVC Or, TC = 200 + 47 = 247)
(iv) Average Variable Cost
When the total variable cost (TVC) is divided by total quantity output (Q) then outcome will
be average variable cost.
TVC 47
or
AVC = Q 10 = 4.7
(v) Average Fixed Cost
When the total fixed cost (TFC) is divided by total quantity output (Q) then the outcome will
be average fixed cost.
TFC 200
or ,
AFC = Q 10 = 20
(iv) Marginal Cost
Ratio between change in total and total quantity output is known as marginal cost.
dTC d
MC = dQ = dQ (200 + 5Q – 0.04Q2 + 0.001Q3)
MC = 5 – 0.08Q + 0.003Q2 when Q = 10
MC = 5 – 0.08 (10) + 0.003 (10)2 = 5 - 0 .8 +0 .3 = 4.5