Embed Size (px)
DESCRIPTION
Cost Relationship using Long Run method
Citation preview
Apr 10, 2023 1
COST OUTPUT RELATIONSHIP IN THE LONG RUN
-K.INIYA
Apr 10, 2023 2
LONG RUN
Long Run is defined as a period in which all inputs can be varied as desired.In Short Run some inputs are fixed(Factory Installation) and some inputs are variable(level of capacity utilization).And in the Long Run all inputs are variable.
Apr 10, 2023 3
COST OUTPUT RELATIONSHIP
There is no fixed cost in long run. Since, the firm has sufficient time to fully replace it’s manufacturing facilities.The Long Run costs would refer to the cost of producing different levels of output by changing the size of the Plant or Scale of Production.
Apr 10, 2023 4
Assume that a Firm at a particular point of time operates under the Average Total Cost curve ATC2
and produces quantity OA.
LONG RUN COST(LAC) CURVE
ATC1
ATC2
Cost per Unit
O AX
c
Y
Apr 10, 2023 5
Now the Manager of the firm decides to produce OB in Future.The new average total cost curve is ATC3.
The Average cost will be BE.
CONTD.,
Cost per Unit
O AX
B
c
ATC1
ATC2
EATC3
Y
Apr 10, 2023 6
Naturally the new Scale operations will be preferred. So, the Average cost of producing Output OB is BD.The Long Run curve is drawn as a Tangential Curve.
CONTD.,
Cost per Unit
Output
LAC
O AX
B
c
ATC1
ATC2
D
EATC3
Y
Apr 10, 2023 7
The BD cost would become Short Run cost (SAC) of producing OB outputs.Each SAC curve will represent a particular scale, including the Optimum Scale.
CONTD.,
Cost per Unit
O X
Y
SAC2SAC3
SAC4
SAC5
SAC6
SAC7
SAC1
Apr 10, 2023 8
The Long Run Cost Curve is drawn as a Tangential curve to all the SAC curves.CONDITIONS:
1.No point in SAC Curve can be below the LAC Curve.
CONTD.,
Cost per Unit
OutputO A
X
Y
A1
LAC
SAC2SAC3
SAC4
SAC5
SAC6
SAC7
SAC1
Apr 10, 2023 9
2.The Shape of LAC curve(U shape) implies that Lower Average Costs in the beginning till the production is reached and then it begins to rise.
3.The LAC curve is never cut by any SAC curve.
CONTD.,
Cost per Unit
OutputO A
X
Y
A1
LAC
SAC2SAC3
SAC4
SAC5
SAC6
SAC7
SAC1
Apr 10, 2023 10
4.LAC Curve will touch the Optimum Scale Curve at the Optimum Curve’s least cost point ie., at A1.
CONTD.,
Cost per Unit
OutputO A
X
Y
A1
LAC
SAC2SAC3
SAC4
SAC5
SAC6
SAC7
SAC1
Apr 10, 2023 11
USEFULNESS OF LAC CURVE
The Firm is interested in producing a given output at the minimum possible cost.
The LAC curve helps the organization to determine the size of the plant to be adopted for producing the given output.
Apr 10, 2023 12
ECONOMICS AND DISECONOMICS
It responsible for the U shaped LAC curve & it concerned with the behavior of average cost as the plant size changes.
The Output increases-> economics of scale.The LAC increases as the output
increases-> diseconomies of Scale.
Apr 10, 2023 13
ECONOMICS AND DISECONOMICS
The Fall in the LAC curve denotes economics of scale & rising side of the LAC curve implies the diseconomies of scale.
In Graph point ‘A’ denotes minimum level. So, in that point economies of scale is equal to the diseconomies of scale.
Apr 10, 2023 14
ECONOMICS AND DISECONOMICS
Marshall classified the economics and diseconomies of large scale production in two types, 1.External Economics. 2.Internal Economics.
Apr 10, 2023 15
EXTERNAL ECONOMICS
It available to all the firms in an Industry.The Discovery of new Process or Machine
which can be used & it benefits for all the Firms.Example:
The Construction of a Railway Line in a certain region which would reduce the transportation cost for all the firms.
Apr 10, 2023 16
INTERNAL ECONOMICS
It available to the particular firm and gives advantage over other firms engaged in the production of same products in the industry.
Internal Economics arise due to the firms own expansion.
Apr 10, 2023 17
INTERNAL ECONOMICS
Internal Economics factors are, 1.Labour economics and diseconomies. 2.Technical economics and diseconomies. 3.Managerial economics and diseconomies. 4.Marketing economics and diseconomies. 5.Financial economics and diseconomies. 6.Diversification in output economics and diseconomies. 7.Diversification of market economics and diseconomies. 8.Risk Spreading economics and diseconomies.
Apr 10, 2023 18
Apr 10, 2023 19
ESTIMATION OF COST- OUTPUT RELATIONSHIP
M.VINOTHA
Apr 10, 2023 20
ESTIMATION OF COST-OUTPUT RELATIONSHIP
When the Output increases total cost also increases.The resulting behaviour of the average cost is that first fall & reach their respective minimum levels and then rise afterwards.The Decision Maker like to know the exact levels.
Apr 10, 2023 21
CONTD.,
This gives rise to the need for an Empirical determination of the Cost-Output relationship facing the firm.Three Ways,
1.Accounting Method 2.Engineering Method 3.Econometric Method
Apr 10, 2023 22
ACCOUNTING METHOD
It calls for estimating the cost output relationship by classifying the Total cost into Fixed, variable and semi variable costs.The average variable cost, the ranges of output within which the semi variable cost is fixed and it’s amount are determined on the basics of inspection and experience.Once all these are done, the output levels are obtained through simple arithmetic.
Apr 10, 2023 23
ENGINEERING METHOD
The Engineering estimate of the cost output relationship is got by estimating the physical units of various input factors like plant size, consumption of materials man-hours and other inputs for a given output.Once the physical units for an output level are determined, they are multiplied by the respected current or expected factor prices.
Apr 10, 2023 24
ECONOMETRIC METHOD
In the econometric method, the Historical data on cost and output are used to estimate the cost output relationship.
The Functional form is chosen and then the least squares method is applied to estimate the chosen form.
Apr 10, 2023 25
CONTD.,
The Common Forms are (a)Linear : TC=a1+b1x
(b)Quadratic: TC=a2+b2x+c2x2
(c)Cubic: TC=a3+b3x+c3x2+d3x3
Where, TC is the Total Cost x is the Quantity
Apr 10, 2023 26
