Microeconomics Ch.6 Cost

Cost

Sum total of actual expenditures on inputs (explicit cost) and the imputed value of the inputs supplied by the owners (implicit cost)

Explicit Cost

Actual money of expenditure on inputs or payment made to outsiders for hiring their factor services
ex. wages to employee, rent for hired premises, pay for raw material

Implicit Cost

Estimated value of the inputs supplied by the owners including normal profit
ex.Estimated Interest on own capital, rent on own land etc

Explicit vs Implicit

EXPLICIT
Payment made to outsiders for hiring factor services
Involves actual money payment on buying & hiring inputs
(examples)

IMPLICIT
Cost of self supplied factors
Involoves imputed value of factors owned by the firm. No money payment involved
(example)

Cost Function

Functional relationship between cost and output
C = f(q)
C: cost of production, q: quantity of output, f:Functional relationship

Opportunity Cost

Cost of the next best alternative foregone

Short Run division

Fixed cost
Variable cost
sum of both gives total cost

TFC or fixed cost

costs which do not vary directly with the level of output (remains same)
ex. rent, salary, insurance premium,interest on loan etc
incurred on fixed factors, payment remains fixed no matter output level.

TFC curve

horizontal straight line parallel to X-axis
Bc TFC remains same at all levels of output

TVC or variable cost

Costs which vary directly with the level of output
Incurred on variable factors, changes with level of output.
Cost incurred during production. Becomes zero at zero level of output.

TVC graph

Starts at origin, Inversely S-shaped
Due to LVP
initially increases at a decreasing rate, bc of better utilisation of fixed factor & increased efficiency of variable factor
Then rises at an increasing rate, bc of fall in efficiency of variable factor due to limit of fixed factor

TVC vs TFC

TVC
costs which vary directly with level or output
can be changed in short run
zero when no production
incurred on variable factor
Curve is S-shaped, VC increases at a decreasing rate, then constant, then at an increasing rate
ex. Wages of casual labour, pay of raw mat.

TVC vc TFC

TFC
Costs which do not vary directly with the level of output
Cannot be changed in the short run
never zero even if there is no production
incurred on fixed factors
Curve is horizontally straight as fixed factors r same in all levels of output
ex. Salary of permanent staff, insurance, building rent

Total Cost

Total expenditure incurred by a firm on the factors of production. Its the sum of TFC and TVC
Change entirely due to TVC

TC curve

Inversely S-shaped due to LVP
TC equal to TFC at zero output
Tc and TVC curves are parallel to each other as vertical distance b/w them is TFC.

Relation b/w TFC, TVC and TC

1. TFC curve horizontal to X-axis bc its constant at all levels of output

2. Tc and TVC are inversely S-shaped because they initially rise at a decreasing rate, then constant and finally at an increasing rate. Shape due to LVP

3. At zero output, TC = TFC bc no VC at zero level of output. Start at same point

4. Vertical distance b/w TFC curve and TC curve is equal to TVC

5. TC and TVC curves are parallel to each other & vertical distance b/w them remains the same at all levels of output bc the gap b/w them is TFC which is constant

Average Fixed Cost

Per unit fixed cost of production
AFC = TFC/Q
AFC falls with increase in output

AFC graph

Rectangular Hyperbola. Does not touch any of the axes
Cant touch X-axis bc TFC can never be zero
Cant touch Y-axis bc at zero level of infinite value

AVC

Per unit variable cost of production
AVC= TVC/Q
Initially falls with increasing output, then when output rises till optimum level, it starts rising

AVC graph

U-shaped due to LVP
Falls due to increasing returns to factor and better utilisation of both factors
After reaching minimum level of output , AVC starts increasing due to diminishing returns
(doesn’t touch the axes but dont write it)

ATC

Cost per unit total cost of production. “
AC= TC/Q