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    Cost Vs Production in Short and Long Run

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    mayura patil
    The document discusses cost concepts and cost functions. It defines different types of costs including total, average, and marginal costs. It explains the relationships between costs and production in the short-run and long-run. Cost functions are influenced by factors like production technology and input prices. In the short-run, costs are categorized into total fixed, total variable, and total costs. In the long-run, all inputs can be varied and costs are fully variable. Economies and diseconomies of scale can occur depending on how average costs change with increasing production levels.

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    Cost Vs Production in Short and Long Run

    Uploaded by

    mayura patil
    1K views32 pages
    The document discusses cost concepts and cost functions. It defines different types of costs including total, average, and marginal costs. It explains the relationships between costs and production in the short-run and long-run. Cost functions are influenced by factors like production technology and input prices. In the short-run, costs are categorized into total fixed, total variable, and total costs. In the long-run, all inputs can be varied and costs are fully variable. Economies and diseconomies of scale can occur depending on how average costs change with increasing production levels.

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    This is a presentation prepared for managerial economics

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    Cost vs Production in Short and Long Run

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    The document discusses cost concepts and cost functions. It defines different types of costs including total, average, and marginal costs. It explains the relationships between costs and production in the short-run and long-run. Cost functions are influenced by factors like production technology and input prices. In the short-run, costs are categorized into total fixed, total variable, and total costs. In the long-run, all inputs can be varied and costs are fully variable. Economies and diseconomies of scale can occur depending on how average costs change with increasing production levels.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    1K views32 pages

    Cost Vs Production in Short and Long Run

    Uploaded by

    mayura patil
    The document discusses cost concepts and cost functions. It defines different types of costs including total, average, and marginal costs. It explains the relationships between costs and production in the short-run and long-run. Cost functions are influenced by factors like production technology and input prices. In the short-run, costs are categorized into total fixed, total variable, and total costs. In the long-run, all inputs can be varied and costs are fully variable. Economies and diseconomies of scale can occur depending on how average costs change with increasing production levels.

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    Download as PPT, PDF, TXT or read online from Scribd
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    of 32

    Introduction

     Cost is the basis of many important decisions


     Cost & revenue are the 2 main factors
     Relation between cost & output is called cost
    function
     Determinates of cost function :
    Production Function
    Prices of Inputs
     Cost of Production = Total Expenses Incurred
    + Normal Profit Expected by Producer
     It provides basis to a product pricing
     Firm’s overall profitability is determined by
    the level of cost relating to revenue
    Types of Costs
     Short run – It is a short period of time with
    in which the firm can varies output by
    varying the amount of variable factors
     E.g. Labour, Raw Material
     Long run – It is a period of time in which
    the quantity of all factors such as variable
    as well as fixed can be changed
     E.g. Capital Equipment & plant
    Cost Functions
    • 1. Total Variable Cost (TVC) – The cost of all
    variable resources
    E.g. Cost of labor, materials, office supplies

    • 2. Total Fixed Cost (TFC) – The cost of all fixed


    inputs
    E.g. Cost of the building, large pieces of machinery,
    certain taxes

    • 3. Total Cost (TC) - the sum of all costs incurred in


    production This the sum of TVC and TFC.
    Total Cost (TC) = TFC + TVC O f(Q)
    R
    4. Average Variable Cost (AVC) – This is
    variable cost per product.

    5. Average Fixed Cost (AFC) – This is


    fixed cost per product.
    AFC = TFC/Q

    6. Average Total Cost (ATC) – This is


    total cost per product.
    O
    ATC = TC/Q R AFC + AVC

    7. Marginal Cost (MC) – This is the cost of


    producing an additional unit of the product.
    MC = TCn – TCn-1
    NATURE OF COSTS
    • Actual cost: cost incurred in production

    • Opportunity cost: return from the second best use


    of firm’s resources which the firm foregoes in order
    to avail the return

    • Explicit / Accounting Costs : Actual money spent


    in purchasing or hiring services of factor.
    Explicit cost is the monetary payment made by the
    entrepreneur for purchasing or hiring the services of
    various productive factors, which do not belong to
    him. This cost is in the nature of contractual payment
    and includes rent for land, wages to the labour ,
    interest on capital, payments for raw materials,
    advertisement, power etc.
    NATURE OF COSTS
     Implicit / Imputed cost: Cost of self-owned
    and self-employed resources.
    Implicit cost of production as “cost of self-
    owned, self employed resources that are
    frequently overlooked in computing the
    expenses of a firm”. it is the amount that
    could be earned in the best alternatives use
    of the entrepreneur's money and time
    NATURE OF COSTS

    • Accounting costs: Cost as stated in books of accounts (explicit cost


    only)

    • Incremental Costs: Total additional cost of implementing a


    managerial decision

    • Historical Cost:

    • Replacement Cost : Cost incurred in replacing


    SHORT-RUN COST FUNCTIONS
    Q TFC TVC TC AFC AVC ATC MC

    0 60 0 60 - - - -

    1 60 20 80 60 20 80 20

    2 60 30 90 30 15 45 10

    3 60 45 105 20 15 35 15

    4 60 80 140 15 20 35 35

    5 60 135 195 12 27 39 55
    Explanation
    • Total fixed cost is constant in the above fig.
    • TVC increases as no of units produced increases.
    • But Fixed cost remain constant irrespective of
    per unit produced
    • So that as TVC increases TC also increases in the
    same proportion
    • Therefore TC = TVC + TFC
    Explanation
    • AVC is in U shape
    • Output AVC & vice versa
    • Therefore ATC also
    • Falling path of ATC is mainly influenced by
    falling of AFC where as rising path of ATC
    is due to rising of AVC
    • When MC<AVC, AVC is falling
    • When MC>AVC, AVC is rising
    • When MC=AVC, AVC is at its minimum
    • MC will always rise more sharply than the
    AVC
    • AFC declines steadily as output increases
    Short-Run & Long-Run Total
    Cost Curves
    • The firm’s long-run total cost curve
    consists of the lowest parts of the
    short-run total cost curves. The long-
    run total cost curve is the lower
    envelope of the short-run total cost
    curves.
    Short-Run & Long-Run
    Average Cost Curves
    SRACs

    LAC

    Q1 Q3
    Q2

    outpu
    t
    Explanation
    • In long run firm can change its output
    because all inputs can be changed
    • 3 SAC curves are of 3 different plants
    • Q2 is the least cost combination as it has the
    minimum point of tangent to LAC
    • In other two cases SAC curves are tangent to
    LAC curve but at that point of tangency
    neither SAC nor LAC is minimum
    • LAC curve stresses economies of scale
    RELATIONSHIP B/W LONG-RUN &
    SHORT-RUN AVERAGE COST CURVES
    RELATIONSHIP B/W LONG-RUN & SHORT-
    RUN AVERAGE COST CURVES
    SR RELATIONSHIP BETWEEN PRODUCTION
    AND COST

    • A firm’s cost structure is intimately related


    to its production process

    • Costs are determined by the production


    technology and input prices
    SR RELATIONSHIP BETWEEN PRODUCTION
    AND COST
    Total
    In order to
    Input
    illustrate the
    (L) Q (TP) MP
    relationship,
    0 0
    consider the
    1 1,000 1,000
    production
    2 3,000 2,000
    process described 3 6,000 3,000
    in table 4 8,000 2,000
    5 9,000 1,000
    6 9,500 500
    7 9,850 350
    8 10,000 150
    9 9,850 -150
    SR RELATIONSHIP BETWEEN PRODUCTION &
    COST
    TOTAL Q (TP) MP TVC (wL) MC
    I/P (L) (∆TVC/
    • Total variable ∆Q)
    cost (TVC) is
    the cost 0 0 0
    associated with 1 1000 1000 500 0.5
    the variable
    input, in this 2 3000 2000 1000 0.25
    case labor 3 6000 3000 1500 0.16
    • Assume that 4 8000 2000 2000 0.25
    labor can be
    hired at a price 5 9000 1000 2500 0.5
    (w) of Rs 500 6 9500 500 3000 1
    per unit
    7 9850 350 3500 1.4
    8 10000 150 4000 3.33
    9 9850 -150 4500
    SR RELATIONSHIP BETWEEN PRODUCTION &
    COST
    • TP and TVC are mirror images of each other
    • When TP increase at an increasing rate, TVC increase
    at a decreasing rate
    RELATION B/W MP & MC
    Total
    • When MP is Input TVC
    (L) Q MP (wL) MC
    increasing, MC 0 0 0
    is decreasing 1 1,000 1,000 500 0.50
    2 3,000 2,000 1,000 0.25
    • When MP is 3 6,000 3,000 1,500 0.17
    decreasing, MC 4 8,000 2,000 2,000 0.25
    is increasing 5 9,000 1,000 2,500 0.50
    6 9,500 500 3,000 1.00
    • Also when MP= 7 9,850 350 3,500 1.43
    8 10,000 150 4,000 3.33
    AP at max AP,
    9 9,850 -150 4,500
    MC = AVC at
    min AVC
    SHORT-RUN COST FUNCTIONS

    Average Variable Cost


    AVC = TVC = w L
    Q Q
    = w = w
    Q/L APL

    Marginal Cost
    ∆ TC/∆ Q = ∆ TVC/∆ Q = ∆ (w L)/∆ Q
    = w = w
    ∆ Q/∆ L MPL
    EXERCISE

    Given Total Cost function:


    TC = 1000 + 10 Q – 0.9 Q 2 + 0.04 Q 3
    Find the rate of O/P that result in minimum
    Average Variable cost
    LR RELATIONSHIP B/W MARGINAL COST AND
    AVERAGE COST
    • All I/Ps to a firm’s production can be changed.

    • No fixed i/ps and fixed costs.

    • All cost of productions are variable.

    • The rate of change of long run total cost function is also


    known as long run marginal cost.

    • Average of the long run marginal cost over a period of


    time is known as long run average cost
    Relation between LRMC and LRAC
    Scale of Total Product LRTC in Rs. LRMC in Rs. LRAC in Rs.
    Production (o/p)Rs

    A 10K 50K 5 5
    B 20K 90K 4 4.5
    C 30K 120K 3 4
    D 40K 150K 3 3.75
    E 50K 200K 5 4
    F 60K 260K 6 4.3
    LR RELATIONSHIP B/W PRODUCTION &
    COST
    LONG RUN AVERAGE COST
    (LRAC)
    Economies of scale
    • When LRAC declines with increase in o/p firm experiences
    economies of scale.
    • Per-unit cost of product is falling .

    Diseconomies of scale
    • When LRAC increases with increase in o/p firm experiences
    diseconomies of scale.
    • Per-unit cost of product is rising
    LONG-RUN COST FUNCTION:
    GENERAL SHAPE
    Factors affecting economies and
    diseconomies of scale
    Economies of scale
    • Specialization in use of labour and capital.
    • Productive capacity of capital equipment rises
    faster then purchase rate.
    • Discounts from bulk purchases.
    • Lower cost of raising capital funds.
    • Efficient management techniques.
    • Spreading of promotional and research and
    development costs.
    Factors affecting economies and
    diseconomies of scale

    Diseconomies of scale
    • Disproportionate rise in transportation costs.
    • Input market imperfections.(wage rates driven
    up)
    • Management coordination and control problems
    • Disproportionate rise in staff and direct labour.
    Thank you

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