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Cost Function - ME

Cost represents the sacrifices involved in making goods and services available to consumers. There are various types of costs including explicit, implicit, fixed, and variable costs. Cost is an important factor for businesses to consider in decision making. In the short run, average and marginal costs are useful concepts, while in the long run all costs are variable. Economies and diseconomies of scale also impact a firm's costs. Revenue is related to costs, as total revenue depends on price and quantity sold, while profit is maximized at the point where marginal revenue equals marginal cost.

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67 views27 pages

Cost Function - ME

Cost represents the sacrifices involved in making goods and services available to consumers. There are various types of costs including explicit, implicit, fixed, and variable costs. Cost is an important factor for businesses to consider in decision making. In the short run, average and marginal costs are useful concepts, while in the long run all costs are variable. Economies and diseconomies of scale also impact a firm's costs. Revenue is related to costs, as total revenue depends on price and quantity sold, while profit is maximized at the point where marginal revenue equals marginal cost.

Uploaded by

DARSHANA S
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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COST

What do you mean by


cost?

Why do they exists?

Why we cannot ignore their


existence in business?
How all this things available for you?
Obviously, the price you paid for it
but who made it available for you?
• A whole lot of effort and time by people,
technology and money involved . This is the
cost of making things available to the
consumer for satisfaction of needs and wants.
• Cost represents sacrificing more than money.
• In economics we call it as cost and now more it
is called as scarifies
Importance of cost

•Study of costs is essential for making a choice


from among the competing production plans
• Cost and revenue are the two major factors
which affect the firms
•From the decision-making point of view cost
is most important than profit
COST - Meaning

• Cost is a sacrifice or foregoing that has occurred or has


potential to occur in future, measured in monetary terms.

•Determinants of Cost – how will you write cost function


•Price of Inputs-who determine?
• Productivity of Inputs- Higher Productivity /lower
Productivity
•Technology – advanced technology
•Level of Output – variations affect cost
Types of costs
•Accounting Costs- It includes accounting, auditing and costing
that can be recorded in the books of accounts
•Examples: cost of raw materials, wages, salary.
•Real Costs – are actually much broader in scope and cover all
aspects of sacrifice involved in acquiring a product (personal
sacrifices)
•Opportunity costs- is concerned with the cost of foregone
opportunities
•Implicit costs- these costs that do not involve actual payment or
cash outflow or reduction in assets, or increase in liability by the
firm for some of the factors of production. .( own land vs leased
land) (mgr vs brother)
Types of costs
•Explicit costs -also known as out-of-pocket costs-refer to
costs that involve current payment to outsiders to the
firm.
•Social Costs – consists of private costs of the firm and
social costs paid by the society.(CSR 2%)
•Replacement Costs - are current price or cost of buying
or replacing any input at present.
•Historic costs- are incurred at the time of purchase of
assets, also regarded as sunk costs.
•Direct Costs – that can be attributed to any particular
activity.( yarn needed, paints etc.,)
Types of costs
•Indirect costs- may not be attributable to output. They
are distributed over all activities (rent for work place,
other benefits)
•Controllable costs- are those subject to regulation by the
management or a firm(internal cost-cost cutting)
•Uncontrollable costs- are beyond the regulation of the
management (taxes-external regulations)
•Production costs - are estimated as a function of the
level of output
•Selling costs- are incurred on making the output available
to the consumer.
Fixed cost

Variable cost

Total cost
Components
of Cost Average Cost

Marginal cost

Cost function of mango pulp


manufacturer
Costs in Short Run
•Short run is a time period where some
factors of production remain fixed and only
few are variable.
Fixed and variable
Fixed costs that do not vary with output
TC
Cost

TVC

TFC

Quantity
Short Run- Average Costs and
Marginal costs
Variable costs –that vary with output, also known as primary cost of
production

MC AC
Cost

AVC

AFC

Quantity
Output TFC TVC TC AFC AVC AC MC
0 500 0
1 500 50
2 500 80
3 500 105
4 500 129
5 500 150
6 500 180
7 500 225
8 500 280
9 500 360
10 500 450
11 500 545
12 500 655
13 500 800
14 500 1020 `
15 500 1350
• Till 5th unit of output how is the TVC –Law of
diminishing marginal utility
• Absorb the AFC till 7th unit and after that
• Absorb AVC- what happen after 5th unit
• MC-At low level of output what
Happens and high levels of output what
happens
Relationship among curves

• Over the output range for which TVC is increasing at a


decreasing rate, both AVC and MC decrease, but MC is les
than AVC.
•MC reaches its minimum point at the output at which TVC
reaches its inflection point, at its minimum, MC is less than
AVC
•For all output levels beyond the minimum of the AVC, both
AVC and MC increases, with MC rising at a faster rate.
•MC is equal to AC when AC is minimum
•Neither TVC nor AVC nor MC is ever negative.
Cost in Long Run

Planning cost function

Planning curve

All cost is variable expect


the average variable cost.
No factor of production remains
constant in long run

Only the average cost curve is relevant


for decision making.

The long run consists of many short


runs like weeks, months, years etc.,

Therefore, many short runs cost curve


is composite of long run cost curve.
Costs in Long Run
• All costs in long run are variable and implies radical
changes in the cost structures of the firm

MC1 SAC1 SAC3


MC2 SAC2
MC3
AC, MC

0 q0 q1 q2
Long Run Marginal Cost Curve
• All costs in long run are variable and implies radical
changes in the cost structures of the firm
SMC3 LMC
SMC1

SAC1 SAC3

SMC2 MC3
LAC
AC, MC

A
SAC2
C
B
q0 q1 q* q2 q3
•Economies of scale mean lowering costs of
production by producing in bulk.
•Internal Economies- cost per unit depends
on size of the firm
Economies
•Specialization
of Scale •Greater efficiency of the machine
•Managerial economies
•Financial economies
•Production in stages
•External Economies- cost per unit depends
on size of the industry not the firm
•Technological Advancement
•Easier access to cheaper raw materials
Economies •Financial institutions in proximity
of Scale •Pooled of skilled workers
•Diseconomies of scale- refers to decrease in
productivity when there are equal increase in
all inputs, assuming that no input is fixed
•Economies of scope- refer to a situation in
which average costs of manufacturing
product are lowered when two
complementary products are produced by a
single firm, than when they are produced
separately.
Revenue • What is revenue
and how it is
related to cost?
Total revenue (revenue) is
the total amount of money
Total received by a firm from
goods sold or services
Revenue(TR) provided during a certain
period of time.
TR=Q.P
Q- Quantity
P-Price
Average revenue is
Average
the revenue earned
Revenue(AR)
per unit of output
sold.
AR=TR/Q
• Marginal Revenue is the
revenue firms gain in
Marginal producing and selling
Revenue(MR) every additional unit of
pdt/services
• MR=change in TR/change
in output
Break even
analysis
Total cost meets the total revenue

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