chapter-cost function of the presentation

It's about managerial Economics

1. Production
Function and
Costs
cost curves
By
Dr. Allah Ditta

2. Background
Before this we have already studied
How producers allocate resources(Production
Possibilities Frontier)
How individuals allocate resources(Consumer
Behaviour)
How buyer and seller use their resources(Demand
Supply)
What is the response of seller and buyer to change
in price or any other factor (Elasticity)
Now we will study how firm manages its cost while
producing

3. Concept of Economic Time Frame
The analysis of production function is generally
carried with reference to time period which are
called “short run” and “long run.”
Short Run:a production time frame in which some
factors of production are variable in amount and
at least one is fixed.
(Hiring part time (overtime) workers to catch high
sale season) (Temporary boost of production)
Long Run: a production time frame in which none of
the input is fixed.
(Opening a new outlet of factory) (permanent
increase output)

4. Type of Economic Costs
Fixed cost: The cost of one factor of production
which does not change with increase in
production, such as rent of building, wages of
security guards.
Total Fixed Cost: The cost of all fixed factors which
remains same and does not change with change
in production.
Variable costs: The cost of one factor of production
which increases with increase in production such as
fuel cost.
Total variable cost: The cost of all variable factors of
production which increase as production
increases and is zero when production is zero.

5. Total Cost = Total variable Cost + Total Fixed Cost
TC = TVC + TFC
Average variable cost (AVC): is the variable cost
per unit of output.
AVC = TVC / Q
Average Fixed Cost: is the fixed cost per unit of
output.
AFC = TFC / Q
Calculation of costs

6. Average Total Cost (ATC):
ATC = (TVC + TFC) / Q
Marginal Cost: The change in total cost when one or
more unit of output is produced.
MC = change in TC/ change in quantity of output
It is the cost incurred on an additional unit of output.
As it is opposite to Marginal product, hence its
curve will be opposite too, it will fall initially and
then rise
Calculation of costsQ
TC
MC


=

7. Q TFC TVC TC AFC AVC ATC MC
0 80 0
1 60
2 110
3 150
4 200
5 260
6 330
Calculation of costs

8. Q TFC TVC TC AFC AVC ATC MC
0 80 0 80 - - - -
1 80 60 140 80 60 140 60
2 80 110 190 40 55 95 50
3 80 150 230 26.6 50 76.6 40
4 80 200 280 20 50 70 50
5 80 260 340 16 52 68 50
6 80 330 410 13.3 55 70 70

9. Family of cost curves
Costs

10. Relationship of AFC, AVC,
ATC and MC
ATC and AVC is falling when MC is below it.
ATC and AVC rises when MC is above.
ATC and AVC is minimum when it is equal to MC.
AFC is always falling
The gap between AVC and ATC is higher at start
but smaller at the end
ATC and AVC is U shaped curves

11. Long Run Costs:
In long run there are no fixed costs, as all costs
become variable.
The fixed cost are zero because in the long run
none of the factor remains constant all of them
are changing so they become fixed cost
For example:
Interest rates change in long run, rent of building
might increase in long run increasing fixed cost.

12. Stages of Long run cost:
When increasing size of production (Output) in long run
causes the per unit cost(Average cost) of production to
fall then its called Economies of Scale.
(while expanding company is buying larger stock of inputs
from wholesale so input costs are falling)
Diseconomies of Scale occur when increasing size of
production in long run causes the per unit cost to rise.
(While expanding they need new managers new
infrastructure which increase cost more than output)
Constant Returns to Scale occur when increasing output
does not affect cost, it remains constant.
(While expanding the cost and output are increase at
same rate)

14. Explicit costs: payments to acquire factors of production.
It is actually transfer of payment from the pocket of
owner
Implicit cost: the best forgone alternative (opportunity
cost of using their own resources).
if the owner is using its own property then he will add
the rent of property which he could have earned if he
had rented out (second best option)
Accounting Profit is total revenue - explicit cost.
Economic Profit is total revenue – (explicit + implicit cost)
As owners costs are recovered even when economic
profit is zero hence it is also called normal profit.
Accounting vs. Economic profit:

15. Illustration
The concept of economic profit shows the aspect
that the manager will only keep the business
working if he sees that he is at least covering the
opportunity cost. So if the economic profit is
negative then the rational manager will quit the
business and work at the second best job.
And it the economic profit is positive then other
people will start to think that this business is a good
investment option hence more manager will start
the business.

16. Conclusion
The numerical showed that when Marginal cost is
equal to Average total cost then the total costs are
ATC is minimum so profit is maximum possible
The knowledge of these cost curves can help firm
managers to decide about whether to increase
output or to decrease.
Profit of firm = Revenue - Cost
The MC = TAC show the minimum cost , hence it will
be the point which is firms best performance
considering its costs to maximise its profit, now we
will study in next chapter how does price changes
can effect profit.

17. Case Study Question
QTYTFCTVCTCAFCAVC ATC MC
0 20
1 8
2 15
3 13.67
4 6
5 7
6 62
7 51