Cost Analysis by UPES university session 2024

Cost analysis ppt on economics

1. COST Analysis By- Dr. Komal Pancholi

2. SHORT RUN V/S LONG RUN COST Short Run : Firms can change the output by varying only variable factors (labor, raw materials) and not the fixed factors (capital equipment, management personnel, etc.) The cost relating to short run is Short Run Cost. Cost corresponding to fixed factors is called Fixed Cost, and Cost corresponding to variable factors is called Variable Cost. Long Run: Producers can change the output by varying all the factors employed; all factors are variable. The cost relating to the long run is called as the Long Run Cost.  

3. SHORT RUN COST 1. Total Fixed Cost (TFC) [Supplementary Cost / Unavoidable Cost] Payments for fixed factors of production in short run. TFC does not change with change in quantity of production. It remains fixed whether the output increases, decreases or is zero. Example, rent of the land, insurance premium, salaries of permanent employees, etc.

4. TOTAL FIXED COST TFC always remains fixed (Rs. 25) at all levels of output (i.e., from 0 units to 8 units). Therefore, TFC – curve is parallel to the X – axis. Units of Output (Q) TFC (Rs.) 25 1 25 2 25 3 25 4 25 5 25 6 25 7 25 8 25 0 1 2 3 4 5 6 7 8 25 X Y Output TFC TFC-curve

5. SHORT RUN COST 2 . Total Variable Cost (TVC) [Prime Cost / Direct Costs] Payments made to the variable factors of production. TVC varies proportionately with the variation in the volume of output. Such costs are ceased as soon as the production is stopped. Example, raw materials, fuel, electric power, temporary labors, etc.

6. TOTAL VARIABLE COST TVC varies directly with the volume of output. Units of Output (Q) TVC (Rs.) 1 20 2 35 3 42 4 48 5 65 6 90 7 120 8 180 TVC TVC 48 O Output X Y

7. TOTAL VARIABLE COST TVC is zero at zero level of output. TVC rises at a diminishing rate up to 4 units of output . Four units of output is the output of Optimal Combination of variable factors. Output of optimal combination is called the Optimal Output. Crossing the optimal output, producer faces increasing rate of cost. Thus, TVC curve is first concave from below and then it becomes convex from below.

8. TFC V/S TVC Fixed Cost Variable Cost No effect on the quantity of output. It varies with the variation in output. Never becomes zero Becomes zero when the production is zero. Cost of the fixed factors of production Cost of the variable factors of production Producer can continue production even at the loss of entire fixed costs. Production is done by the firms, only if the variable costs are fulfilled. Fixed cost curves starts from an intercept point above the origin and are horizontal to the x – axis. Variable cost curves starts from origin. It is first concave and then convex from below.

9. TOTAL COST Total Cost (TC) is the payments made to the fixed and the variable factors of production to produce a given amount of output in a given time period.  

10. TFC, TVC, and TC Units of Output (Q) TFC (Rs.) TVC (Rs.) TC (Rs.) 5 5 1 5 5 10 2 5 8 13 3 5 10 15 4 5 11 16 5 5 13 18 6 5 16 21 7 5 20 25 8 5 25 30 9 5 32 37 10 5 42 47 TFC TC TVC O 4 X Y 5 11 16 TFC/TVC/TC Output

11. TFC, TVC, and TC TC starts from the point where TFC starts above the origin showing same characteristics of TVC. Since TFC remains constant, the change in TC are entirely due to the change in TVC. Therefore, TC and TVC have similar shape. TVC starts from the origin, while TC starts from an intercept above the origin, from where TFC starts. From the equation, , which shows that vertical distance between TC and TVC gives TFC which is constant from beginning to end. , vertical distance between TC and TFC gives TVC , which keeps increasing as output rises.  

12. UNIT COSTS IN SHORT RUN 1. Average Fixed Cost (AFC) Cost of fixed factor per unit of output produced. Since, TFC remains fixed, AFC would fall as the firm produces more output. Therefore , AFC curve slopes downward throughout its length. With very large output, AFC approaches zero but never becomes zero ( never touches X – axis ) and always remain positive. When output produced is very small, AFC rises and tend to become equal to the TFC. Any point on AFC curve, corresponding AFC multiplied by Q, gives the TFC which is same at any point on AFC curve throughout. Hence, AFC curve forms a Rectangular Hyperbola.  

13. AFC Units of Output (Q) TFC (Rs.) AFC (Rs.) 1 20 20 2 20 10 3 20 6.67 4 20 5 5 20 4 6 20 3.33 7 20 2.86 8 20 2.5 9 20 2.22 10 20 2 20 15 10 5 O 5 10 Y X AFC-curve AFC

14. UNIT COSTS IN SHORT RUN 2 . Average Variable Cost (AVC) Cost of variable factor per unit of output produced. Due to Law A Variable Proportion , the AVC is different at different levels of output. TVC increases first at a less proportional rate and beyond a certain amount of output increases at a more proportional rate. Following these, the AVC curve first falls, reaches a minimum and then begins to rise.  

15. AVC Units of Output (Q) TVC (Rs.) AVC (Rs.) 1 25 25 2 40 20 3 54 18 4 60 15 5 90 18 6 138 23 7 210 30 8 304 38 9 432 48 10 600 60 AVC keeps on falling sharply up to the fourth unit of output produced, after which it rises sharply. Its minimum point is at ‘M’ corresponding to the fourth unit of output. AVC curve is “U” shaped. 15 M 4 AVC Curve X Y AVC Output

16. AC or ATC Average Cost (AC) or (ATC) Cost of per unit of output produced. AC being the sum of AFC and AVC shows the same characteristics of AVC. Having kept AFC, the AC curve stands above the AVC curve. Likewise, AVC curve, the AC curve first falls and beyond a certain point it rises.  

17. AC, AVC and AFC Q TFC TVC TC AFC AVC AC 1 20 18 38 20 18 38 2 20 30 50 10 15 25 3 20 40 60 6.66 13.33 20 4 20 52 72 5 (13) 18 5 20 65 85 4 13 (17) 6 20 84 104 3.33 14 17.3 7 20 105 125 2.86 15 18 8 20 144 164 2.5 18 20.5 9 20 189 209 2.22 21 23.2 10 20 260 280 2 26 28 AFC AC AVC A B 4 5 17 13 O X Output Y AFC/AVC/AC

18. ATC, AVC and AFC AC keeps falling till 5 th unit of output and rises after that level of output. Virtual summation of AFC curve and AVC curve gives the AC curve. Thus, AC curve lies above the AVC curve at a distance which is equal to the height of AFC curve. Vertical difference between AC curve and AVC curve gives AFC curve. Vertical difference between AC and AFC curve gives the AVC curve. Minimum point of the AC occurs to right of minimum point of AVC. AVC curve reaches first its minimum point at a lower rate of output before the AC curve does. AC and AVC after reaching their respective minimum starts rising and tends to come closer to the expansion of output produced but never touches each other. The gap between AC and AVC curves is nothing but the height of AFC curve which goes on declining but never becomes zero.

19. NUMERICAL What should be the firm’s profit/ loss, when Average variable cost is Rs . 20 per unit, Average Fixed Cost is Rs.10, price of the output is Rs . 25 per unit and only 8 units are produced?

20. Output 1 2 3 4 5 Total cost 50 80 100 150 250 750 Given the following table of costs: Calculate the following: ( i ) Fixed cost (ii) Average cost of production (iii) Variable cost per unit (iv) Marginal cost

21. The following table gives the total cost schedule of a firm. It Is also given that the average fixed cost at 4 units of output is Rs. 5. Calculate TVC, TFC, AVC, AFC Q Total cost 1 50 2 65 3 75 4 95 5 130 6 185