Cost Flashcards
What is Cost of Production?
Refers to the expenditure incurred by a firm on fixed and variable inputs to produce a commodity.
What is Cost in Economics?
Cost in economics is the summation of explicit costs, implicit costs and normal profits.
- Explicit Costs - These are those payments that the firm makes to outsiders for the use of their goods and services. Eg. wages to labour, expenditure on purchase of raw materials etc.
- Implicit Costs - These are the self-owned and self-employed resources of the owner. Eg. rent on owner’s own building, wages on owner’s own services
- Normal Profits - Refers to the minimum returns that a firm must get to continue production.
What is Total Cost?
Total Cost refers to the total expenditure incurred on the fixed and variable factors in order to generate output.
- TC = Total Fixed Cost + Total Variable Cost*
- TC = TFC + TVC*
What is the difference between fixed cost and variable cost?
1. Cost - FC, expenditure inccurred on fixed factors of production. VC, expenditure incurred on variable factors of production.
2. Value - FC, remains constant whether output is 0 or max. VC, is 0 when output 0 and increases with increase in output.
3. Concept - FC, prevails only in short run. VC is prevelant in both the short run and the long run.
4. Graphically - TFC curve straight line, perfectly elastic, || to x axis. TVC starts from origin and takes an inverted S shaped curve.
Eg. FC, rent on land, interest on capital. VC, electricity charges, wages to labour
What is Average Cost/Average Total Cost?
Refers to the per-unit cost of production.
AC = TC/Output
AC = AFC + AVC
AC = Average Fixed Cost + Average Variable Cost
What is Average Fixed Cost? What is the shape of its slope?
Refers to the per-unit cost of the fixed factor of production.
AFC = TFC/Output
AFC continously diminishes with increase in output as TFC constant. Thus, slope of AFC, will be of a rectangular hyperbola.
What is Average Variable Cost? What is its shape?
Refers to the per-unit cost of the variable factor of production.
AVC = TVC/Output
AVC curve is U-shaped in nature because of the law of variable proportions (LVP). It implies that initally the AVC curve will fall and after reaches minimum point it begins to rise.
Draw a graph representing AC, AVC, AFC
NOTE: The gap between AVC and AC will keep reducing as gap is AFC
What is Marginal Cost?
Refers to the change in total output due to the application of an additional unit of variable input.
MC = #TC/#Output
MC = TCn - TCn-1
MC = TVCn - TVCn - 1(As only variable cost changes, TFC fixed)
Explain the relationship between AC and MC
- When MC < AC, AC falls
- When MC = AC, AC is minimum
- When MC > AC, AC rises
Explain the relationship between AVC and MC
- When MC < AVC, AVC falls
- When MC = AVC, AVC is minimum
- When MC > AVC, AVC rises
Why is the short-run AC curve U-shaped in nature ?
The short-run AC curve is U-shaped in nature because:-
- Basis of Law of Variable Proportions
The AC curve is U-shaped, that is initially it falls, when more of the variable factors are more than optimally co-ordinated with the fixed factors. (increasing returns to factor)
Then AC reaches its minimum point and production will be maximum due to optimum co-ordination and ideal ratio between the factors. (constant returns to factors)
Finally, the AC rises and the production falls due to poor co-ordination and imperfect subsitution between the factors. (diminishing returns to factors)
- Basis of AFC and AVC
The AC curve is a summation of AFC and AVC curves. The AFC is a rectangular hyperbola, that is it conotinually diminishes with increase in output, but never falls to 0. Whereas, the AVC curve initially falls and after reaching minimum point, begins to rise. Thus by combining AFC and AVC, we get a U-shaped AC curve.
TC (In terms of TFC, TVC)
TC = TFC + TVC
ATC/AC (In terms of TC, Output)
AC = TC/Output
AC (In terms of other AFC, AVC)
AC = AFC + AVC
Cost Formulae
Hints
