Costs of

Production
Family of cost curves
Concept of Economic Time Frame
The analysis of production function is generally carried with
reference to time period which are called “short run” and
“long run.”
Short Run: a production time frame in which some factors of
production are variable in amount and at least one is fixed.
(Hiring part time (overtime) workers to catch high sale season)
(Temporary boost of production)
Long Run: a production time frame in which none of the input
is fixed.
(Opening a new outlet of factory) (permanent increase output)
Type of Economic Costs
Fixed cost: The cost of one factor of production which does
not change with increase in production, such as rent of
building, wages of security guards.
Total Fixed Cost: The cost of all fixed factors which remains
same and does not change with change in production.
Variable costs: The cost of one factor of production which
increases with increase in production such as fuel cost.
Total variable cost: The cost of all variable factors of
production which increase as production increases and is
zero when production is zero.
Calculation of costs

Total Cost = Total variable Cost + Total Fixed Cost

TC = TVC + TFC

Average variable cost (AVC): is the variable cost per unit of

output.
AVC = TVC / Q
Average Fixed Cost: is the fixed cost per unit of output.
AFC = TFC / Q
Calculation of costs
Average Total Cost (ATC):
ATC = (TVC + TFC) / Q
Marginal Cost: The change in total cost when one or more
unit of output is produced.
MC = change in TC/ change in quantity of output

MC  TC
Q
It is the cost incurred on an additional unit of output. As it is
opposite to Marginal product, hence its curve will be
opposite too, it will fall initially and then rise
Law of Diminishing returns and Costs
We have seen already Max. Output
increase in inputs have Output
higher benefit at start but Costs
lower at the end
So costs are opposite to
benefit, there will be low
cost at the start and high
at the end
Hence for profit
maximization, output
maximization is also
cost minimization are
two methods Min. Cost

# of Input units
Calculation of costs
Q TFC TVC TC AFC AVC ATC MC

0 80 0

1 60

2 110

3 150

4 200

5 260

6 330
Q TFC TVC TC AFC AVC ATC MC

0 80 0 80 - - - -

1 80 60 140 80 60 140 60

2 80 110 190 40 55 95 50

3 80 150 230 26.6 50 76.6 40

4 80 200 280 20 50 70 50

5 80 260 340 16 52 68 50

6 80 330 410 13.3 55 70 70

Family of cost curves

Costs
Relationship of AFC, AVC, ATC
and MC
 ATC and AVC is falling when MC is below it.
 ATC and AVC rises when MC is above.
 ATC and AVC is minimum when it is equal to MC.
 AFC is always falling
 The gap between AVC and ATC is higher at start but smaller
at the end
Long Run Costs:
In long run there are no fixed costs, as all costs become
variable.

For example:
Interest rates change in long run, rent of building might
increase in long run increasing fixed cost.
Stages of Long run cost:
 When increasing size of production (Output) in long run causes
the per unit cost(Average cost) of production to fall then its
called Economies of Scale.
(while expanding company is buying larger stock of inputs from
wholesale so input costs are falling)
 Diseconomies of Scale occur when increasing size of
production in long run causes the per unit cost to rise.
(While expanding they need new managers new infrastructure
which increase cost more than output)
 Constant Returns to Scale occur when increasing output does
not affect cost, it remains constant.
(While expanding the cost and output are increase at same rate)
Accounting v.s. Economic profit:
Explicit costs: payments to acquire factors of production. It is
the costs hiring F.O.P.
Implicit cost: the best forgone alternative (opportunity cost of
using their own resources).
if the owner is using its own property then he will add the rent
of property which he could have earned if he had rented out
Accounting Profit is total revenue - explicit cost.
Economic Profit is total revenue – (explicit + implicit cost)
As owners costs are recovered even when economic profit is zero
hence it is also called normal profit.
Conclusion
 The numerical showed that when Marginal cost is equal to
Average total cost then the total costs are ATC is minimum so
profit is maximum possible
 The knowledge of these cost curves can help firm managers to
decide about whether to increase output or to decrease.

Profit of firm = Revenue - Cost

 The MC = TAC show the minimum cost , hence it will be the
point which is firms best performance considering its costs to
maximise its profit, now we will study in next chapter how
does price changes can effect profit.