COST AND PRODUCTION ANALYSIS

CHAPTER 4

PRESENTED BY

SYEDA MUNAZA
SUHAIL
SUBRAMANYA M
RACHANA
PRAJWAL P
PALLAVI
NISHANTH H.S 1ST YEAR MBA (KAUTILYA)
VICKY MAHARAJA INSTITUTE OF TECHNOLOGY
NANDAN SUBMITED TO :
RANJITHA Asst Prof NANDAN GIRI K
 Introduction of Cost &
Production Analysis

• Cost
• Cost of Production
• Cost Concept
Output relationship in short
run cost
•Short run total cost curves:
Short run Average &
Marginal cost curve
ACC OUNTING CONCEPT

• OPPORTUNITY COST
• BUSINESS COST & FULL COST
• EXPLICIT COST & IMPLICIT COST
• OUT OF POCKET & BOOK COST
OPPORTUNITY COST

Opportunity cost is the opportunity lost.An

opportunity to make income
Is lost because of scarcity of resources like
land,labour,capital etc..
BUSINESS COST

Business cost includes all the expenses that are incurred to carry
out a business.
It includes all the payments and contractual obligations made by
the firm together with the book cost depreciation on plant &
Equipments.Business cost are used for Calculating business
profit& losses and for filing returns for income tax and also for
other legal purpose.
FULL COST

Full cost includes business cost, opportunity cost and

normal profit.A normal profit is necessary a
minimum earning in addition to the opportunity
cost,which a firm must receive to remain in it’s
present occupation.
EXPLICIT COST

Explicit cost are those which are actually

incurred by the firm in payment for labour,
Material, Plant, Building, Machinery, Equipment
etc..
IMPLICIT COST

There are other certain other cost that

donot take in form of cash outlays nor do
the appear in the accounting system.Such
cost are known as implicit cost.
ECONOMIC COST

The explicit and implicit cost both make the

economic cost.
OUT OF POCKET COST

The item of expenditure that involve cash payments

or cash transfers both reccuring and non reccuring
are known as out of pocket cost.
BOOK COST

There are certain actual business cost that don’t

involve cash payments but a provision is therefore
made in the books of account & they are taken into
account while finalizing the profit & loss accout.
A N A L Y T I C A L COST CONCEPT
SThe analytical cost concepts refers to
the different concepts that are used
in analyzing the cost- output
relationship with increase in inputs
and outputs and also the cost
concepts that figure in analyzing the
effect of expansions of production on
the society as a whole.
ANALYTICAL COST CONCEPTS

Fixed And Variable Cost

Total, Average And Marginal Costs
Short-Run And Long-Run Cost
Incremental Costs And Sunk Costs
Historical And Replacement Cost
Private And Social Costs
F I X E D AND V A R I A B L E COST
Fixed Cost:- are that remain fixed an amount for a
certain quantity of output. Fixed cost those not vary with
variation in the output between zero and a certain of
output. In other words, cost that do not vary or remain
constant for a certain level of output are treated as fixed
cost.

Variable Cost:- those which vary with the variation in

the total output. Variables cost include cost of raw
material, running cost of fixed capital, such as fuel, repairs
routine maintenance expenditure, direct labour charge
associated with the labour of the output and the costs of
all other inputs that vary with outputs.
 TOTAL, AVERAGE AND MARGINAL
COSTS
Total Cost:-
refers to the total outlays of money expenditure, both
explicit and implicit, on the resources used to produce a
given level of output. It includes both fixed and variable
cost.

Average Cost:-
is of statistical nature-it is not actual cost. It is obtained
dividing the total cost (TC) by the output.

Marginal Cost:-
is defined as the addition to the total cost on account of
producing one additional unit of the product. Or, marginal
cost is the cost of the marginal unit produced.
 SHORT–RUN A N D L O N G – RU N COST

 Short-Run:- Short-run refers to the time period during

which scale of production remain unchanged.
The cost incurred in the sort-run are called sort-run costs.
It includes both the variable and the fixed costs.

 Long-Run:- Long-run costs, on the other hand, are

those that are incurred to increase the scale of production
in the long-run. The costs that incurred on the fixed
factors like plant, building, machinery, etc. are known as
long-run cost.
INCREMENTAL COSTS
AND SUNK COSTS
Incremental Cost::
are closely related to the concept of marginal cost but with
a relatively wider connotation. While marginal cost refers to
the cost of the marginal unit (generally 1 unit) of output,
incremental cost refers to the total additional cost associated
with the decisions to expand the output or to add a new
variety of product, etc.

Sunk Costs:
are those which are made once and for all and cannot we
altered, increased or decreased, by varying the rate of
output, nor can they be recorded.
 HISTORICAL A N D REPLACEMENT COST

Historical Cost::
refers to the cost incurred in past on the acquisition of
productive assets, e.g. land, building, machinery, etc.

Replacement Cost:
refers to the expenditure made for replacing an old asset. These
concepts owe their significance to the unstable nature of input
prices. Stable prices over time, other given, keep historical and
replacement costs on par with each other. Instability in asset
prices makes the two costs differ from each other.
 P R I VAT E A N D SOCIAL C O S T

Private Cost::
those which are actually incurred or for provided for by an
individual or a firm on the purchase of goods and services from the
market. For a firm, all the actual costs, both explicit and implicit,
are private costs. Private costs are internalized costs
that are incorporated in the firm’s total cost of
production.

Social Cost::
the other hand, refers to the total cost born by the society due
to production of commodity. Social costs include both private
cost and the external cost.
LONG RUN
COSTCURVE
PRODUCTION WITH ONE
VARIABLE INPUT

The law of production states that the

relationship between output and input.in
the short run input, output relations are
studied with one variable input that is
labour,other input especially capital held
constant .the laws of production under this
condition are called the law of variable
proportion or the law of returns to variable
inputs
THE LAW OF DIMINISHING MARGINAL
UTILITY
LAW OF DIMINISHING MARGINAL
UTILITY CAN BE FURTHER
EXPLAINEDWITHTHE HELP OF 3
STAGES OF PRODUCTION
THREE STAGES IN
PRODUCTION FUNCTION
CONCLUSION:

Given the emplacement of fixed factor

(capital) ,when more and more workers
are employed, the returns from additional
workers may increase intially but
eventually decreses
Isoquants

Meaning-
the term isoquant “is composed with two terms
‘iso’ and ‘quants’. Iso in Greek word which means
equal, quant in Latin word means quantity.
Therefore, this two word together refers to equal
quantity or equal product”
An isoquant curve is the
representation of a set of locus
of different combinations of two
inputs (labor and capital) which
yield the same level of output. It
is also known as or equal product
curve or producer’s indifference
curve.
Example for isoquant curve
Assumptions of Isoquant Curve
The concept of isoquant is based on the
following assumptions.
1.Only two inputs (labor and capital) are
employed to produce a good.
2.There is technical possibility of
substituting one input for another. It
implies that the production function is of
variable proportion type.
3.Labor and capital are divisible.
4.The producer must be rational,
i.e. trying to maximize his profit.
5.State of technology is given and
unchanged.
6.Marginal rate of technical
substitution diminishes in
production process.
 Properties of Isoquant Curve
• Isoquant is convex to the
origin
• Isoquant is negatively sloped
• Higher isoquant represents
higher production
• Two isoquants never intersect
each other
Isoquants is convex to the origin
Isoquant is negatively sloped
Two isoquants never intersect each other
Higher isoquant represents
higher production
 Low of return to scale
The lows of returns to scale explain the behaviour of
output in response to a proportional and
simultaneous changes in input. Increasing inputs
proportional and simultaneous is , in fact, an
expansion of the scale of production.
Accordingly , there are three kinds of returns to
scale:
i. Increasing returns to scale;
ii. Constant returns to scale,
iii. Diminishing returns to scale.
1. Increasing returns to
scale
When inputs, K&L , are increased at a certain
proportion & output increases more than
proportionately , it exhibits increasing return to
scale.
For example, If qualities both the inputs , K & L , are
successively doubled and the resultant output is
more than doubled , the returns to scale is set to be
increasing. The increasing returns to scale is
illustrated in fig.
Factors behind increasing
return to scale :
i. Technical and managerial indivisibilities.
ii. Higher degree of specialization.
iii. Dimensional relation.

2. Constant returns to scale:

when the increase in output is proportionate
to the increase in inputs , it exhibits constants
returns to scale .
For example, if quantities of both the inputs , K
and L , are doubled and output is also doubled ,
than the return to scale are said to be constant .

3. Decreasing return to scale :

The firms are faced with decreasing returns to
scale when a certain proportionate increase in
inputs, K and L, leads to a less than
proportionate increase in output.
Causes of diminishing to
scale
The decreasing returns to scale are
attributed to the diseconomies of
scale . The economists find that the
most important factor causing
diminishing returns to scale is the
diminishing return to management,
managerial diseconomies.
 OPTIMUM FACTOR COMBINATION (or)
PRODUCER EQUILIBRIUM (or) LEAST
COST COMBINTION

Meaning:

least cost combination refers to the combination

of factors with which a firm can produce a
specific quantity of output at the lowest possible
cost.
Least cost combination principles

 A rational firm/producer seeks maximization of profit.

 For this ,he tries to minimize its cost of production.
 The cost is minimum, when input combination is optimal
 Optimal input combination indicates the maximum returns to the factors
employed.
 Producer’s equilibrium occurs when he earns maximum profit with optimal
combination of factors .
 A profit maximization producer faces two choice of optimal combination
of factors

1.To minimize its cost for a given output.

2.To maximize its output for given cost.
Economies of
Scale:
Internal and
External
 I. Internal Economies:

 As a firm increases its scale of production, the firm enjoys several

economies named as internal economies. Basically, internal
economies are those which are special to each firm. For example,
one firm will enjoy the advantage of good management; the other
may have the advantage of specialisation in the techniques of
production and so on.
These economies are of the following types:

1. Technical Economies:

Technical economies have their influence on the size of the firm. Generally,
these economies accrue to large firms which enjoy higher efficiency from
capital goods or machinery. Bigger firms having more resources at their
disposal are able to install the most suitable machinery.
 2. Marketing Economies:

 When the scale of production of a firm is increased, it enjoys numerous

selling or marketing economies. In the marketing economies, we include
advertisement economies, opening up of show rooms, appointment of
sole distributors etc. Moreover, a large firm can conduct its own research
to effect improvement in the quality of the product and to reduce the cost
of production. The other economies of scale are advertising economies,
economies from special arrangements with exclusive dealers.


3. Labour Economies:

 As the scale of production is expanded their accrue many labour

economies, like new inventions, specialization, time saving production
etc. A large firm employs large number of workers. Each worker is given
the kind of job he is fit for. The personnel .officer evaluates the working
efficiency of the labour if possible. Workers are skilled in their operations
which save production, time and simultaneously encourage new ideas.
 II. External Economies:

 External economies refer to all those benefits which accrue to all the firms
operating in a given industry. Generally, these economies accrue due to the
expansion of industry and other facilities expanded by the Government.
According to Cairncross, “External economies are those benefits which are
shared in by a number of firms or industries when the scale of production in
any industry increases.” Moreover, the simplest case of an external
economy arises when the scale of production function of a firm contains as
an implicit variable the output of the industry. A good example is that of coal
mines in a locality.

1. Economies of Concentration:

As the number of firms in an area increases each firm enjoys some

benefits like, transport and communication, availability of raw materials,
research and invention etc. Further, financial assistance from banks and
non-bank institutions easily accrue to firm.
 2. Economies of Information:

 When the number of firms in an industry expands they become mutually

dependent on each other. In other words, they do not feel the need of
independent research on individual basis. Many scientific and trade
journals are published. These journals provide information to all the firms
which relates to new markets, sources of raw materials, latest techniques
of production etc.

 3. Economies of Disintegration:

 As an industry develops, all the firms engaged in it decide to divide and

sub-divide the process of production among themselves. Each firm
specializes in its own process. For instance, in case of moped industry,
some firms specialize in rims, hubs and still others in chains, pedals, tires
etc. It is of two types-horizontal disintegration and vertical disintegration.
 Diss Economic Scale
 Though there are good number of advantage in the large of
production.
 This happens because costs are spread over a larger number
of goods, costs can be both Fixed and variable

• Over work management

• Over production
• Difficulty in decision making
• Co ordination
• Financial dificicay
• Labour Dis-economic
 Technological Changes

1. Natural Technology Change

2 . Labour Saving Techniques
3 . Capital Saving Techniques