Professional Documents
Culture Documents
Theory of Cost
Theory of Cost
Theory of Cost
Introduction
The firms decision on profit maximizing output depends on the behavior of its costs as well as on the behavior of its revenue. A firms production is commonly thought of as its monetary expenses. In order to produce a good, every firm makes use of various
Cost analysis
Cost analysis refers to study behavior of cost in relation one or more production criteria like size
Accounting cost
Accounting cost are those cost which are actually incurred & recorded in the books of accounts by the firm in payment for various factors of production.
Ex /:
Wages to workers employed Rent for the building he hires
Economic cost
The normal return on money capital invested by the entrepreneur himself in his own business (implicit cost)
Ex :
The wages & salary not paid to the entrepreneur but could have been earned it the services had been sold somewhere
else.
ECONOMIC COST = ACCOUNTING COST + IMPLICIT COST
Outlay cost
Involves actual expenditure of funds
Eg: wages, rent, interest, etc,.
sometimes.
Fixed cost
FIXED COST:
Fixed cost are costs which do not change with changes in the quantity of output In words of FERGUSON total fixed cost is the sum of the short run explicit fixed and the implicit costs incurred by an entrepreneur.
In includes
Rent Salary of administrative staff Interest on fixed capital Insurance Property tax and licence fee Normal profit Depreciation and maintenance etc
Variable cost
Variable cost:
Total variable cost are those costs which are incurred on the use of variable factors of production.
Total cost
Opportunity cost
Is the cost of any activity measured in terms of the value of the best alternative that is not chosen.
have produced.
The opportunity cost is the cost of next best alternative foregone, it is also called alternative cost.
Various cost
Money cost:
The amount spent in terms of money for the production of a commodity is called money cost.
Real cost:
Real cost refers to the pains, the discomfort and disutility involved in supplying the factors of production by their owners.
Accounting cost:
Accounting costs refer to cost payments which firms make for factor and non factor inputs , depreciation and other book keeping entires.
Cost function
The cost function refers to the mathematical relation between of a produce and the various determinants of cost.
C = f (q, T, pf, k)
Where
c = Total cost q = Quantity produced i.e., output T = Technology pf = factory price K = captial
Cost function
increases.
If no output is produced, then total variable cost is zero; the larger the output, the greater the total variable cost.
COST
Economies of Scale
0 Q1
Diseconomies of Scale
Q
Total cost
Total Cost (TC) describes the total economic cost of production and is made up of variable costs. Total cost in economics includes the total opportunity cost of each factor of production as part of its fixed or variable costs.
Total cost
The total cost of producing a specific level of output is the cost of all the factors of input used. total cost=total fixed cost + total variable cost
Average cost
The average cost is the total cost divided by the number of units produced. It is the total cost divided by the quantity of output produced.
Average cost
Average costs affect the supply curve and are a fundamental component of supply and demand.
Marginal cost
The marginal cost of production is the increase in total cost as a result of producing one extra unit.
Marginal cost
The concept of marginal cost in economics is similar to the accounting concept of variable cost. Marginal costs are not constant.
Marginal cost
For example a factory may be operating at the highest capacity it can with all workers working normal full time hours, so increasing production by one more unit would mean paying overtime, so the marginal cost would be higher than the current variable cost per unit.
REVENUE THEORY
Revenue is the income that a firm receives from selling its products, goods and services over a certain period of time Revenue may be measured in three ways: 1. Total Revenue (TR) 2. Average Revenue (AR) 3. Marginal Revenue (MR)
Total revenue
Total revenue is the total receipts of a firm from the sale
Total revenue
It can be calculated as the selling price of the firm's product times the quantity sold
Total Revenue
For example:if 100 ice-cream slabs are sold at the rate of 50 rupees per slab, total revenue of the firm will be.. Quantity x price = total revenue 100 x 50 = 5000
Average revenue
Average revenue is the per unit revenue received from the sale of commodity. AR= Total revenue/no of unit sold
Marginal revenue
Marginal revenue is the increase in revenue from
It differs from the price of the product because it takes into account the effect of changes in price. Marginal revenues and costs can be further broken down into long run and short run