12/12/23, 12:54 AM What is Cost Function?

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What is Cost Function?

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What is Cost Function?

Cost Function refers to the relationship between input costs and output. In
simple terms, the functional relationship between cost and output is referred
to as the cost function. It is written as:

C = f(q)

Where,

C = Cost of Production;

q = Quantity of Production; and

f = Functional Relationship

There are different types of costs, including Average Costs, Marginal Costs,
Fixed Costs, and Variable Costs.

Total Costs

In the short run, some of the factors are fixed, while other factors are
variable. In the same way, the short-run costs are also categorised into two
different kinds of cost; viz., Fixed Costs and Variable Costs. The sum total of
these costs is equal to the Total Cost.

1. Total Fixed Cost (TFC) or Fixed Cost (FC)

The costs on which the output level does not have a direct impact are known
as Fixed Costs. For example, salary of staff, rent on office premises, interest
on loans, etc. Other names of fixed costs are Supplementary Cost,
Overhead Cost, Unavoidable Cost, Indirect Cost, or General Cost.
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The costs on which the output level has a direct impact are known as
Variable Costs. For example, fuel, power, payment for raw materials, etc.
Other names of variable costs are Prime Cost, Avoidable Cost, or Direct
Cost.

3. Total Cost (TC)

The total expenditure incurred by an organisation on the factors of
production which are required for the production of a commodity is known as
Total Cost. In simple terms, total cost is the sum of total fixed cost and total
variable cost at different output levels.

TC = TFC + TVC

Average Costs

Average costs are the per unit costs which explain the relationship between
the cost and output in a realistic manner. These per-unit costs are obtained
from Total Fixed Cost, Total Variable Cost, and Total Cost. The three
different types of per-unit costs are as follows:

1. Average Fixed Cost (AFC)

The per unit fixed cost of production is known as Average Fixed Cost. The
formula for calculating Average Fixed Cost is:

2. Average Variable Cost (AVC)

The per unit variable cost of production is known as Average Variable Cost.
The formula for calculating Average Variable Cost is:

3. Average Total Cost (ATC) or Average Cost (AC)

The per unit total cost of production is known as Average Total Cost or
Average Cost. The formula for calculating Average Total Cost is:

Another way to define Average Total Cost is by the sum of Average Fixed
Cost and Average Variable Cost; i.e., AC = AFC + AVC.

Marginal Cost
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12/12/23, 12:54 AM What is Cost Function? - GeeksforGeeks

The additional cost incurred to the total cost when one more unit of output is
produced is known as Marginal Cost. For example, if the total cost of
producing 2 units is ₹400 and the total cost of producing 3 units is ₹600,
then the marginal cost will be 600 – 400 = ₹200.

{Where, n = Number of units produced; MCn = Marginal cost of the nth unit;
TCn = Total cost of n units; TCn-1 = Total cost of (n-1) units}

Another way to calculate Marginal Cost:

When the change in the units produced is more than one unit, then the
previous formula of calculating MC will not work. In that case, the
formula for calculating Marginal Cost will be:

For example, if the total cost of producing 4 units is ₹300 and the total
cost of producing 2 units is ₹50, then the marginal cost will be:

Marginal Cost = ₹125

Examples of Short-Run Costs

Example 1:
From the table below, calculate the missing figures.

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12/12/23, 12:54 AM What is Cost Function? - GeeksforGeeks

At all output levels, TFC remains constant at ₹15.

Example 2:
From the table below, calculate the missing number.

Solution:

Working Notes:
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12/12/23, 12:54 AM What is Cost Function? - GeeksforGeeks

2. *TC = AC x Q

Example 3:
From the table given below, calculate the weekly TC and AVC.

Solution:
TC = TVC + TFC

TVC = Raw materials used + Power + (Number of workers employed x

Weekly wage)

TVC = 1,800 + 350 + (70 x 300)

TVC = ₹ 23,150

AVC = TVC/Units Produced per week

AVC = 23,150/200

AVC = ₹ 115.75

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Last Updated : 07 Aug, 2023 1

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