Cost

COSTMADE BY : SYED

ARIF AHMAD

TYPES OF COST

EXPLIT COST

IMPLICIT COST

PRIVATE COST

SOCIAL COST

MONEY COST

REAL COST

OPPORTUNITY COST

What do mean by COST???Production and cost are two side of a same coin. There can not be any production without incurring cost and at the same time cost without production has no economic significance.

1) SHORT RUN

2) LONG RUN

Short Versus Long RunThe short run is a period of time sufficiently

short that only some of the variables can be changed.

The long run is a period of time that all variables can be changed.

SHORT RUN COST

Total cost = Total fixed cost + Total variable cost

MCn = TCn – TCn-1

AC = AFC +AVC

Variable CostsThese costs exist only if production occurs.

E.g., fuel for tractor, seed, etc.

Fixed CostsThese cost exist whether production occurs or not.

In the long-run there are no fixed costs.

Can be both cash and non-cash expenses.

E.g., depreciation on tractors and buildings, etc.

Cont...Sunk Costs

Is an expenditure that cannot be recovered.In essence, it becomes part of fixed costs.E.g., pre-harvest costs.

Cost ConceptsTotal Fixed Costs (TFC)

The summation of all fixed and sunk costs to production.

Total Variable Costs (TVC)The summation of all variable costs to

production.Total Costs (TC)

The summation of total fixed and total variable costs.

TC=TFC+TVC

Cost Concepts Cont.Average Fixed Costs (AFC)

The total fixed costs divided by output.Average Variable Costs (AVC)

The total variable costs divided by output.Average Total Costs (ATC)

The total costs divided by output.The summation of average fixed costs and

average variable costs, i.e., ATC=AFC+AVC.

Cost Concepts Cont.Marginal Costs

The change in total costs divided by the change in output. TC/Y

The change in total variable costs divided by the change in output. TVC/Y

Side Note on Marginal CostHow can marginal cost equal both the change

in total cost divided by the change in output and the change in total variable cost divided by the change in output when variable costs are not equal to total costs?Short answer: fixed costs do not change.

Graphical Representation of Cost Concepts`

Y

TC

TVC

TFC

y

x0

COSt

output

TOTAL FIXED COSTEg :- rent

TFC

output xo

cost

y

TOTAL VARIABLE COST Y TVC

O QTY X

(IT IS DUE TO LAW OF VARIABLE PROPORTION)

TOTAL COSTTFC + TVC

TC

TVC

TFC

XQTY O

Y

COST

MARGINAL COST

MC

X O QTY

Y

COST

AVERAGE FIXED COSTAFC = TFC/OUTPUTOptimum combination b/t fixed & variable

factors.It will not touch Y & X axis, it tends towards

zero, but never reaches zero. y

cost

o outpu

t

X

Contd…output TFC AFC

0 100 0

1 100 100

2 100 50

3 100 33.3

4 100 25

AVERAGE VARIABLE COSTAVC = TVC /OUTPUT

AVC Y

COST

O OUTPUTX

AVERAGE COSTAC =TC/OUTPUT

AC

Y

COST

QTY XO

Relationship between AC & AVC

0

y

x

RELATIONSHIP BETWEEN AC & AVC

Ac lies above AVC

Minimum point of AVC comes before miminum point of AC

Diffrence between Ac & AVC is AFC

AVC connot intersect AC because AFC never becomes 0.

RELATIONSHIP BETWEEN AC & MC

AC

y

x

MC

Relationship between AC & MC

When AC decreases MC is less then AC

When AC increases MC is more than AC

MC intersect AC at its minimum point

Long-Run Average CostsThe long run average cost (LRAC) curve is

the envelope of the short run average cost curves when the size of the operation is allowed to increase or decrease.

Note that a short run average cost curve exists for every possible farm size, as defined by the amount of fixed input available.

LONG RUN COST CURVE

Due to variable proportion & optimum combination between fixed & variable factor, U shape is form

& for LRAC :- Law of Returns to Scale