COST ANALYSIS

Mr. P. Nandakumar Assistant Professor KVIMIS

Costs

Costs

In buying factor inputs, the firm will incur costs Costs are classified as:
Fixed costs costs that are not related directly to production rent, rates, insurance costs, admin costs. They can change but not in relation to output Variable Costs costs directly related to variations in output. Raw materials primarily contribute to variable costs

Costs

Total Cost - the sum of all costs incurred in production TC = FC + VC Average Cost the cost per unit of output AC = TC/Output Marginal Cost the cost of one more or one fewer units of production MC = TCn TCn-1 units

Total Variable Cost(TVC)

LABOR 0 1 2 3 4 5 6 7 8 TOTAL PRODUCT 0 3 15 36 48 56 62 66 68 TOTAL VARIABLE COST (TVC) 0 48 96 144 192 240 288 336 384

The labor costs is $48 per day

Total Variable Cost(TVC) Curve

Cost 700 600 500 400 300 200 100 0 Q TVC

20

40

60

80

THE TOTAL VARIABLE COST CURVE shows the total variable cost at each level of output

Total Cost

If there are fixed costs (costs associated with inputs that cant be changed), then we can add these to the total variable costs to get total costs. Total Cost = Fixed Cost + Total Variable Cost

TC = FC + TVC

Total Cost (Fixed cost + Variable cost)

LABOR 0 1 2 3 4 5 6 7 8 TOTAL VARIABLE PRODUCT COST(VC) 0 3 15 36 48 56 62 66 68 0 48 96 144 192 240 288 336 384

FIXED COST(FC)
150 150 150 150 150 150 150 150 150

TOTAL COST(TC)
150 198 246 294 342 390 438 486 534

Total Cost (Fixed cost + Variable cost)

Cost 700 600 500 400 300 200 100 Q 0 20 40 60 80 TVC TC

The total cost curve shows the total cost of producing each output.

Graphical Analysis of Total Costs

Total costs
C

Total costs rise dramatically as output increases after diminishing returns set in
Output

Short Run Average Cost (SAC)

Average Variable Cost (AVC)

The Short run Average cost(SAC) incurred by the firm is defined as the total cost per unit of output SAC = TC/Q

The average variable cost (AVC) is defined as the total variable cost per unit of output AVC = TVC/Q AFC = TFC/Q SAC = AVC + AFC

Short run marginal cost

The short run marginal cost (SMC) is defined as the change in total cost per unit of change in output
SMC =change in total cost/change in output
SMC=TC/Q where represents the change of the variable

Various Concepts of Costs

Output [Q] (units) 0 1 2 3 4 5 TFC (Rs) TVC (Rs) TC [TFC+TVC ] 20 30 38 44 49 53 AFC [TFC/Q] (Rs) 20 10 6.67 5 4 AVC [TVC/Q] (Rs) 10 9 8 7.25 6.6 SAC [TC/Q] (Rs) 30 19 14.67 12.25 10.6 SMC [TVCn-TVCn1] (Rs) 10 8 6 5 4

20 20 20 20 20 20

0 10 18 24 29 33

6
7 8 9 10

20
20 20 20 20

39
47 60 75 95

59
67 80 95 115

3.33
2.86 2.5 2.22 2

6.5
6.7 7.5 8.33 9.5

9.83
9.57 10 10.55 11.5

6
8 13 15 20

Graphical Analysis of Total Costs

Average and marginal costs

MC is the slope of the C curve

MC AC

If AC > MC, AC must be falling If AC < MC, AC must be rising

Minimum AC

Output

Shape of various Cost Curves

TC-Total Cost TFC-Total Fixed cost TVC-Total Variable cost MC Marginal cost ATC- Average total cost AVC- Average Variable cost AFC-Average Fixed Cost

Long run Cost

In the long-run there are no fixed inputs, and therefore no fixed costs. All costs are variable. Another way to look at the long-run is that in the long-run a firm can choose any amount of fixed costs it wants for making short-run decisions.

Long-run Cost curve

The long-run average cost curve shows the minimum average cost at each output level when all inputs are variable, that is, when the firm can have any plant size it wants. There is a relationship between the LRAC curve and the firm's set of short-run average cost curves.

SR and LR Average Costs

Economists use the term plant size to talk about having a particular amount of fixed inputs. Choosing a different amount of plant and equipment (plant size) amounts to choosing an amount of fixed costs. Economists projects fixed costs as being associated with plant and equipment. Bigger plants have larger fixed costs.

If each plant size is associated with a different amount of fixed costs, then each plant size for a firm will give us a different set of short-run cost curves. Choosing a different plant size (a long-run decision) then means moving from one short-run cost curve to another.

Economists usually assume that plant size is infinitely divisible (variable). In the case of finely divisible plant size, the LRAC U-shaped curve might look Each like small this:
curve is a SAC curve.
LRAC

cost

The LRAC curve.

Average costs for a typical firm.

Quantity

In the preceding graph, each short-run cost curve corresponds to a particular amount of fixed inputs. As the fixed input amount increases in the long run, you move to different SR cost curves, each one corresponding to a particular plant size.

Types of Cost

Money cost Real cost Explicit and implicit cost Opportunity cost Fixed cost and variable Short run and long run cost Incremental cost and sunk cost Shutdown and abandonment cost Social cost

Money cost includes the wage and salaries paid to a worker, expenditure on machinery and equipment and their needed repairs ,payment of raw materials, power, light, fuel and transportation. The Real cost of production of a commodity is expressed not in money but in the efforts of workers and sacrifices undergone in making the commodity. An Explicit cost is a direct payment made to others in the course of running a business, such as wage, rent and materials, as opposed to Implicit costs, which are those where no

Opportunity cost

Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen (that is foregone) For example, A businessman buy either a lathe machine or paper printing machine and he can earn Rs.50,000 and Rs.70,000 respectively from two alternatives. A real business man will go for paper printing machine. In this he loses the oppurtunity of earning Rs.50,000 from lathe machine. This Rs.50,000 is called opportunity cost

Sunk cost & Incremental cost

Sunk cost are the costs already incurred in a project that cannot be changed by present or future actions. For example, if a company bought a piece of machinery five years ago, that amount of money has already been spent and cannot be recovered. Incremental cost is the additional cost of producing a given increment of output. How much does the firms total costs change if the volume of a particular service increases (or decreases) by a given amount

Social cost

If there is a negative externality, then social costs will be greater than private costs. Environmental pollution is an example of a social cost that is seldom borne completely by the polluter, thereby creating a negative externality. If there is a positive externality, then one will have higher social benefits than private benefits.

Abandonment costs & shutdown cost

Abandonment costs are costs associated with the abandonment of a business venture. This was traditionally an oil and gas term that referred to the abandonment of an underproducing or non-producing oil well A firm will shutdown production when the revenue received from the sale of the goods or services produced cannot even cover the variable costs of production. In that situation, the firm will experience a higher loss when it produces, compared to not producing