Dr.

Vishwanath Karad World Peace University

School of Management (PG)

Faculty of Management
Managerial Economics

UNIT IV
Cost and Production analysis
 Learning Points

Cost and Production analysis :

4.1 Cost concepts –Economic cost, Accounting cost,
Opportunity cost, explicit and implicit cost, controllable
costs, Fixed and variable costs
4.2 Cost-output relationship- Total, average and marginal
costs
4.3 Production Analysis: Short run and long run
production function
4.4 Economies of scale
 Cost Concept
An amount that has to be paid or given up in order to get something is known as
cost.

In business, cost is usually a monetary valuation of

(1) effort,
(2) material,
(3) resources,
(4) time and utilities consumed,
(5) risks incurred, and
(6) opportunity forgone in production and delivery of a good or service. All
expenses are costs, but not all costs (such as those incurred in acquisition of
an income-generating asset) are expenses.
 Cost Concepts
Accounting cost & Economic cost
Opportunity cost
Incremental cost and sunk cost
Controllable cost & Non Controllable cost
Fixed Cost & Variable cost
 Cost Output relationship
Units of Fixed Cost Variable Total cost Average Average Average Marginal
Output Cost Fixed Cost Variable Total Cost Cost
Cost
0 1000 0 1000 Nil

1 1000 50 1050 1000 50 1050 50

2 1000 90 1090 500 45 545 40

3 1000 140 1140 333 47 380 50

4 1000 196 1196 250 49 299 56

5 1000 255 1255 200 51 251 59

6 1000 325 1325 167 54 221 70

7 1000 400 1400 143 57 200 75

8 1000 480 1480 125 60 185 80

9 1000 570 1570 111 63 174 90

10 1000 670 1670 100 67 167 100

11 1000 780 1780 91 71 162 110

12 1000 1080 2080 83 90 173 300

 Production Function

• Production function refers to the functional relationship

between the quantity of good produced (output) and the
factors of production (inputs) necessary to produce it.

• According to Watson, “The relation between a firm’s

physical production (output) and the material factors of
production (inputs) referred to as production function.”
 Production Function

• Fixed and Variable Factors of Production

• A fixed factor of production is one whose quantity cannot
readily be changed. Examples include major pieces of
equipment, suitable factory space, and key managerial
personnel.
• A variable factor of production is one whose usage rate
can be changed easily. Examples include electrical power
consumption, transportation services, and most raw
material inputs.
 Economies of scale
The Scale of Production
Production on a large scale is a very important feature of modern industrial
society. As a consequence, the size of business undertakings has greatly
increased. Large-scale production offers certain advantages which help in reducing
the cost of production. Economies arising out of large-scale production can be
grouped into two categories; viz., internal economies and external economies.
Internal economies are those economies of production which accrue to the firm
when it expands its output, so that the cost of production would come down
considerably and place the firm in a better position to compete in the market
effectively. Internal economies arise purely due to endogenous factors relating to
efficiency of the entrepreneur or his managerial talents or the type of machinery
used or the marketing strategy adopted. These economies arise within the firm and
are available exclusively to the expanding rm. On the other hand, external
economies are the benefits accruing to each member firm of the industry as a
result of expansion of the industry.
 Economies and diseconomies of scale

Internal Economies External Economies

Technological economies Cheap inputs
Managerial Economies Development of Skilled Labour
Commercial economies Growth of ancillary industries
Financial economies Better market facilities
Risk bearing economies Economies of information
Thank You