COST

THE EXPENDITURE INCURRED ON VARIOUS INPUTS IS KNOWN AS COST OF

PRODUCTION.
COST OF PRODUCING A GOOD IN ECONOMICS IS THE SUM TOTAL OF ALL THE –
a) DIRECT EXPENDITURE (ACTUAL MONEY EXPENDITURE OF A FIRM ON PURCHASING
GOODS OR HIRING FACTOR SERVICES, CALLED EXPLICIT COST) AND
b) INDIRECT EXPENDITURE ( IMPUTED VALUE OF THE OWNER’S ESTIMATED VALUE OF
INPUTS PROVIDED CALLED IMPLICIT COSTS) AND
 EXPLICIT COST
It refers to those cash payments which the firm makes to outsiders for their
goods and services.

IMPLICIT COSTS
They are the cost of self supplied factors of production, which are generally
not recorded in a firm’s account book.

TYPES OF EXPLICIT COSTS – SHORT RUN COSTS

Short run costs are those in which some factors of production and others are
variable. It consists of-

FIXED COST VARIABLE COST

Costs incurred on variable factors of

Costs incurred on fixed factors of production like raw material, wages of casual
production like land, machine &building labour, fuel etc.
TOTAL FIXED COST ( SUPPLEMENTARY/ INDIRECT COST/ OVERHEAD COST )
Fixed costs are those costs which do not change with a change in output.
These are the costs incurred on fixed factors of production like rent of factory
building, salaries of permanent employees etc.
The shape of the TFC is horizontal or parallel to the x axis (as they remain
fixed whether the output is increased or decreased or becomes zero. )
TFC = TC - TVC
TOTAL VARIABLE COST (PRIME OR DIRECT COST)
Payment made to the variable factors of production are known as variable cost. (eg.
Wages of casual labour, payment for raw material etc.)
TVC is very much related to the production and fluctuates with the fluctuation in
production. TVC goes on increasing with the increase in the level of output. In case of
zero level of production TVC would also be zero.
TOTAL COST
TOTAL COST consists of both total fixed cost and total variable cost. The expenditure
incurred on various costs of production is known as total cost.
TC = TFC + TVC
Diagrammatically TC curve can be obtained by adding vertically the TFC curve and
the TVC curve.
TFC, TVC AND TC CURVES
AVERAGE FIXED COST
The per unit cost incurred on fixed factors of production is known as average fixed
cost
AFC = TFC
OUTPUT
AFC falls as output increases
AVERAGE VARIABLE COST
The per unit cost incurred on variable factors of production is known as AVC
AVC = TVC
Q
The AVC curve is U shaped because of Law of Variable Proportions
AVERAGE TOTAL COST / AVERAGE COST (ATC)
The per unit cost incurred on various factors of production is known as average cost. In
other words, it is the sum total of average variable cost and average fixed cost.
ATC/AC =TC or AC = TFC + TVC
Q Q
AC = AFC + AVC
AC curve is U-shaped because of the Law of Variable proportions.
 AFC, AVC AND ATC CURVES

C
O
S
T

UNITS OF COMMODITY
MARGINAL COST
The cost incurred on additional unit of output is known as Marginal cost. The shape of
MC depends on the shape of TVC or TC
MC = TC n + 1 – TC n or MC = TC
TQ
Relationship between short run costs
Types of Short run Costs
 C

E1

A E

The difference between AC and AVC shows AFC.

RELATIONSHIP BETWEEN AC AND AVC
* The difference between AC and AVC shows AFC
* As the output increases, the distance between AC and AVC curves goes on
decreasing but they never meet each other

Output (in Rs.) TC ( in Rs.) AC (in Rs.)

1 20 20
2 30 15
3 36 12
4 48 12
5 75 15
6 120 20
Relationship between Average cost and marginal cost
 MC>AC
MC<AC

E AC=MC

B
Difference between fixed cost and variable cost
 Long Run Costs
In the long run all inputs are variable. Therefore, there is no TFC or AFC curves.
There is no distinction between TC and TVC, thus only the term TC is used.
There is no distinction between ATC and AVC, so only the term long run average cost
LAC is used
The marginal cost is denoted by LMC
REAL COST
All the mental and physical exertion in the production of goods constitute the real
cost. It is not expressed in monetary form.

PRIVATE COST
Private costs are incurred privately by the enterprise. They are borne by the firm itself.
Eg. Purchase of raw materials, payment of wages, salaries etc.

SOCIAL COST
The cost that is borne by others, other than the firm is known as external cost. Social
cost is the total of private cost and external cost. Eg. Smoke emitted by the chimneys
of factories, air, water and land pollution caused by factories etc.