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MEFA Notes Unit 3

The document discusses various types of costs involved in production and business analysis. It describes 7 types of costs including fixed and variable costs, opportunity and actual costs, sunk and incremental costs. It also discusses total, average and marginal costs. Cost curves are presented including short-run and long-run cost curves. Short-run costs include fixed, variable and total costs. Optimum output is determined by where marginal cost equals marginal revenue to maximize profit.

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Pankaj Kumar
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224 views3 pages

MEFA Notes Unit 3

The document discusses various types of costs involved in production and business analysis. It describes 7 types of costs including fixed and variable costs, opportunity and actual costs, sunk and incremental costs. It also discusses total, average and marginal costs. Cost curves are presented including short-run and long-run cost curves. Short-run costs include fixed, variable and total costs. Optimum output is determined by where marginal cost equals marginal revenue to maximize profit.

Uploaded by

Pankaj Kumar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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MEFA-Ch-3

Production and Cost Analysis

Cost concept- The cost of production is an important factor in almost all business analysis and decision.
The concept of cost is important because of the following points-

a) To locate the weak points in production management.

b) To minimize the cost

c) To find the optimum level of output.

d) To determine the price and dealer margin.

e) Estimating or projecting the cost of business operations.

Types of cost
1. Explicit and implicit cost- The Explicit cost, also called as Actual Cost is the cost actually incurred by
the firm for making all the physical payments and the contractual obligations. An implicit cost, also called
an imputed cost, implied cost, or notional cost, is the opportunity cost equal to what a firm must give up
in order to use a factor of production for which it already owns and thus does not pay rent.

2. Fixed and variable cost- Fixed cost are those which are fixed in volume for a certain given output.
Fixed cost does not vary with variation in the output. On the other hand Variable cost are those which
vary with the variation in the total output.

3. Opportunity and actual cost- It may be defined as the expected return from the second best use of the
resources which are foregone due to the scarcity of resources. It is also called alternative cost. Actual cost
are those which are actually incurred by the firm in payment for labour, Material, plant, machinery,
building etc.

4. Sunk and incremental cost- Sunk cost are those which cannot be altered, increase or decrease by
varying the rate of output. Incremental cost refers to the total additional cost with the decision to expand
the output or to add a new variety of product.

5. Business cost and full cost- The concept of business cost in similar to the actual cost. The concept of
full cost include business cost, opportunity cost and normal profit.

6. Total, average and marginal cost- Total cost is the total expenditure incurred in the production of
goods and services. Average cost can be obtained by dividing the total cost by total output and Marginal
cost is the addition to the total cost on account of producing an additional unit (MC= TCn – TCn-1)

7. Short run and long run cost- All the cost incurred on the variable factors such as labor and raw
material constitutes the short-run cost. The long run is a period of time in which all factors of production
and costs are variable. In the long run, firms are able to adjust all costs.

Cost curves

The cost curve for a company or a product is the graph containing the total cost as a function of the total
quantity produced. The graph exhibits the overall profitability of the company or the product by mapping
its current position on the graph and comparing it with the best alternative.

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MEFA-Ch-3

The quantity for which the marginal cost curve crosses the marginal revenue curve i.e. marginal cost =
marginal revenue, that quantity is the optimum quantity to be produced in case of maximum profit. The
total cost curve, average cost curve, marginal cost curve, total revenue curve, average revenue curve and
the marginal revenue curve, all incorporate the same axes and hence, they can be shifted from one graph
to another, thus, helping in finding the optimum quantity.

Short run cost curve

Long run cost curve

Cost and output decisions

Short-Run Costs and Output Decisions

Costs in the Short-Run

 Fixed Costs– any cost that does not depend on the firm’s level of output.
 Variable Costs– costs that depend on the level of output chosen.
 Total Costs– fixed costs plus variable costs.

TC = TFC + TVC

 Average Fixed Costs– a per unit measure of fixed costs.


 Average Variable Costs– a per unit measure of costs that depend on the level of output chosen.
 Average Total Costs– a per unit measure of all costs.

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MEFA-Ch-3

ATC = AVC + AFC

Marginal Costs– the additional cost of producing one additional unit of a good or service.

Output Decisions: Profit Maximization


 Total Revenue– the amount received from the sale of the product
 Marginal Revenue– the additional revenue that a firm makes from selling one additional unit of a
good or service.

Profit Maximization level of output is MR = MC.

Short-run Supply Curve


The MC curve above the AVC.

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