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Costs Concepts Class Slides
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Transcript of Costs Concepts Class Slides
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Costs concepts
Study of behavior of cost in relation toproduction, size of output, scale of
operations, prices of factors ofproduction.
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Determinants of costs
1. Laws of returns ie incase of incresing returnsthe cost is less and incase of decresing returnsit is incresing.
2. Costs is effected by the size of plant.3. Time period longer the time period costs would
rise slowly whereas in case of short runproduction the initial cost would be high.
4. Technology.5. Size of plant ,incase of bigger lot the cost per
unit would be less.
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Types of costs
1. Accounting costs
2. Opportunity costs
3. Fixed cost and the variable costs
4. Business costs -all costs incurred to carry the business, whereasthe full costs includes business ,opportunity, and the normal profit.
5. Incremental costs are the total additional costs needed to expandthe production.
6. Sunk costs are the costs which have already been incurred andcannot be recovered, nor altered ,increased or decreased byvarying the rate of output.
7. Private costs which are actually borne by the firm for the
production process whereas8. Social costs are the costs which the society has to bear while the
production process takes place eg effluents into the river by therifineries.
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Costs in the Short Run
The short run is a period of timefor which two conditions hold:1. The firm is operating under a fixed
scale (fixed factor) of production, and2. Firms can neither enter nor exit an
industry.
In the short run, all firms havecosts that they must bearregardless of their output. Thesekinds of costs are called fixedcosts.
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Costs in the Short Run
Fixed costis any cost that does not
depend on the firms level of output.
These costs are incurred even if the
firm is producing nothing.
Variable costis a cost that depends
on the level of production chosen.
TC TFC TVC ! Total Cost = Total Fixed + Total Variable
Cost Cost
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Fixed Costs
Firms have no control over fixedcosts in the short run. For thisreason, fixed costs aresometimes called sunk costs.
Average fixed cost (AFC) is thetotal fixed cost (TFC) divided by
the number of units of output (q):
AFCTFC
q!
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Short-Run Fixed Cost (Total and
Average) of a Hypothetical Firm
AFC falls as output
rises; a phenomenon
sometimes called
spreading overhead.
(1)q
(2)TFC
(3)AFC(TFC/q)
0 $1,000 $
1 1,000 1,000
2 1,000 500
3 1,000 333
4 1,000 250
5 1,000 200
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Variable Costs
The total variable cost curve is agraph that shows the relationship
between total variable cost and the
level of a firms output. The total variableThe total variable
cost is derived fromcost is derived from
productionproduction
requirements andrequirements andinput prices.input prices.
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Marginal Cost
Marginal cost (MC) is the increase in total cost thatresults from producing one more unit of output.
Marginal cost reflects changes in variable costs.
Change in fixed cost is zero in the short run.
MC TCQ
TFCQ
TVCQ
! !
(
(
(
(
(
(
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Derivation ofMarginal Cost from
TotalV
ariable CostUNITSOFOUTPUT
TOTAL VARIABLECOSTS ($)
MARGINALCOSTS ($)
0 0 0
1 10 10
2 18 8
3 24 6
Marginal costmeasures the
additionalcost of inputs required
to produce each successive unit of
output.
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The Shape of the Marginal Cost
Curve in the Short Run The fact that in the short run everyfirm is controlled by some fixed input
means that:
1. The firm faces diminishing returns to
variable inputs, and
2. The firm has limited capacity to
produce output. As a firm approaches that capacity,
it becomes increasingly costly to
produce successively higher levels
of out ut.
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The Shape of the Marginal Cost
Curve in the Short Run Marginal costs ultimately increase
with output in the short run.
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Graphing Total Variable Costs
andM
arginal Costs Total variable costsalways increase with
output. The marginal
cost curve shows how
total variable cost
changes with single unit
increases in total output.
Below 100
units of output,Below 100
units of output,TVCTVCincreases at aincreases at a
decreasing ratedecreasing rate. Beyond 100. Beyond 100
units of output,units of output, TVCTVCincreasesincreases
at anat an increasing rate.increasing rate.
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Average Variable Cost
Average variable cost (AVC) is
the total variable cost divided by
the number of units of output. Marginal cost is the cost ofone
additional unit. Average variable
cost is the average variable costper unit ofall the units being
produced.
Average variable cost follows
marginal cost, but lags behind.
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Total Costs
the total cost curve hasthe total cost curve has
the same shape as thethe same shape as the
total variable costtotal variable cost
curve; it is simplycurve; it is simply
higher by an amounthigher by an amount
equal toequal to TFCTFC..
TC TFC TVC !
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Average Total Cost
Average total cost(ATC) is total costdivided by the number
of units of output (q).ATC AFC AVC!
ATCTC
q
TFC
q
TVC
q
! !
BecauseBecause AFCAFCfalls withfalls withoutput, an everoutput, an ever--decliningdecliningamount is added toamount is added to AVCAVC..
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Relationship Between Average
Total Cost and Marginal Cost1. ATC is the summation
of AVC and AFC.
2.In the biggning AVCandAFC falls hence the
ATC falls sharply.3.MC also falls and is
below than AVC in theinitial stage,reches
minimum and thenrises.
4.ATC falls reachesminimum and then
rises.
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Output Decisions: Revenues,
Costs, and ProfitM
aximization In the short run, a competitive firm faces a
demand curve that is simply a horizontal
line at the market equilibrium price.
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Total Revenue (TR) and
Marginal Revenue (MR)
Total revenue (TR) is the total amount that
a firm takes in from the sale of its output.
TR P q! v
MRTR
q! !
P q
q
( )(
(
Marginal revenue (MR)Marginal revenue (MR) is the additional revenueis the additional revenue
that a firm takes in when it increases output bythat a firm takes in when it increases output by
one additional unit.one additional unit.
In perfect competition,In perfect competition, P= MRP= MR..
! P
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Comparing Costs and
Revenues toM
aximize Profit The profit-maximizing level of output forall firms is the output level where MR=MC.
In perfect competition, MR= P, therefore,the profit-maximizing perfectlycompetitive firm will produce up to thepoint where the price of its output is just
equal to short-run marginal cost. The key idea here is that firms will
produce as long as marginal revenueexceeds marginal cost.
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Profit Analysis for a Simple Firm
(1)q
(2)TFC
(3)TVC
(4)MC
(5)P= MR
(6)TR
(Px q)
(7)TC
(TFC+ TVC)
(8)PROFIT
(TR TC)
0 $ 10 $ 0 $ $ 15 $ 0 $ 10 $ -10
1 10 10 10 15 15 20 -52 10 15 5 15 30 25 5
3 10 20 5 15 45 30 15
4 10 30 10 15 60 40 20
5 10 50 20 15 75 60 15
6 10 80 30 15 90 90 0
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The Short-Run Supply Curve
At any market price, the marginal cost curve shows the
output level that maximizes profit. Thus, the marginal
cost curve of a perfectly competitive profit-maximizing firmis the firms short-run su l curve.