Cost Curves

Cost Curves, Introduction, Types of Costs (Accounting costs, real cost, Implicit Cost, Opportunity cost, Explicit cost, Social cost, Imputed and Sunk Cost), Types of cost curves (Short run cost function, Relationship between Total Cost, Fixed Cost and Variable Cost, Costs in Long run, Conclusion.

1. COST CURVES COMPILED AND PRESENTED BY: Dr. Ruchika Batra

2. INTRODUCTION DEFINITION: Cost may be defined as a sacrifice or foregoing which has already occurred or has potential to occur in future with an objective to achieve a specific purpose measured in monetary terms. Cost results in current or future decrease in cash or other assets, or a current or future increase in liability. Determinants of Cost: Price of inputs Productivity of inputs Technology Level of Output

3. TYPES OF COSTS 1. ACCOUNTING COSTS: An  accounting cost  is recorded in the ledgers of a business, so the  cost  appears in an entity's financial statements. Examples: Cost of raw materials Wages and Salary Interest on Loan 2. REAL COSTS : Real costs are more or less social and psychological in nature and non-quantifiable in money terms. The modern concept of compensation packages is strongly driven by the real cost component of total cost, as besides normal salary employers try to compensate for leisure, social and family needs, etc. 3 . IMPLICIT COSTS: These are the costs that do not involve actual payment or cash outflowor reduction in the assets. These arise when a firm makes use of its own resources which include : Own Building Costs of self - owned or self - employed resources Own Land

4. 4. OPPORTUNITY COSTS: Opportunity cost is the benefit forgone from the next best alternative that is not selected. Individuals or firms give up an opportunity to use or enjoy something in order to select something else. For example: In case of choices: you may be working in your hometown and suppose you have got another job opportunity in a city far away from your hometown. Now if you select the new job, you would be forgoing the benefits of staying at home. This would be your opportunity cost of the new job. 5. EXPLICIT COSTS: Also known as out of pocket costs or accounting costs . These are the costs that are entered in the Trading and Profit and Loss Account. For Example: Interest on Loan, Office expenses, Salaries, etc

5. 6. SOCIAL COSTS: Social costs of the firms are those that society in general has to bear because of the firm’s activities. For Example: Pollution caused by industrial wastes and emissions. It has 2 components: A) Private costs of the firm, B) Social costs paid by the society. 7. SUNK COSTS:   A sunk cost is a cost that has already been incurred and cannot be recovered. For Example: A) Your rent, marketing campaign expenses or money spent on new equipment can be considered  sunk costs . B) Cost incurred in constructing a Factory.  8. IMPUTED COSTS: An  imputed cost  is a  cost  that is incurred by virtue of using an asset instead of investing it or undertaking an alternative course of action. For example, if a firm occupies a building that it owns, it forgoes the opportunity of renting it out for some other use.

6. Fixed Variable Variable Fixed TYPES OF COST CURVES

7. SHORT RUN COST FUNCTION In the short-run, the firm cannot change or modify fixed factors such as plant, equipment and scale of its organization. In this the output can be increased or decreased by changing the variable inputs like labor, raw materials, etc. TOTAL FIXED COSTS (TFC) These are the Costs that DO NOT vary with the output. These costs are NOT affected by the changes in volume of production. It included: Property Tax Rent Depreciation

8. TOTAL VARIABLE COSTS (TVC) These are the costs that vary with the output and are incurred in getting more and more inputs. Variable costs are equal to zero if there is no output. Includes: Cost of raw material Wages Total Cost = Total Fixed Cost + Total Variable Cost

9. AVERAGE FIXED COST(AFC) AFC is the fixed cost per unit of output and thus, Average Fixed Cost = Total Fixed Cost Unit Output As the number of units of output is Increased, fixed cost remaining same, AFC falls steeply at first and then gently. AVERAGE VARIABLE COST (AVC) AVC is variable cost per unit of output and thus, Average Variable Cost = Total Variable Cost Unit Output

10. Relationship between Total Cost, Fixed Cost and Variable Cost TFC curve is a horizontal straight line parallel to X-axis as it remains constant at all levels of output. TC and TVC curves are inversely S-shaped because they rise initially at a decreasing rate, then at a constant rate and finally, at an increasing rate. This shape is determined by the law of variable proportions. At zero output, TC = TFC because there is no variable cost as zero level output. So, TC and TVC curves start from the same point, which is above the origin.

11. MARGINAL COST (MC) Marginal Cost refers to the addition to total cost when one more unit of output is produced. MC n = TC n – TC n-1 Where, n is the number of units produced Thus, Marginal Cost (MC) = △TC △Q Relationship between Average and Marginal Cost Curves

12. As output increases, the gap between AC and AVC falls. As output increases, the gap between AC and AFC increases. AVC never intersects AC due to the gap of AFC, AFC needs to be zero so as to make AVC intersect AC. MC intersects AC and AVC at their lowest points.

13. COSTS IN LONG RUN All costs are variable in the long run since factors of production, size of plant, machinery and technology are all variable. It is often referred to as the “Planning Cost Function” and the Long Run Average Cost (LAC) curve is also known as “Planning Curve” or “Envelope curve”. LONG RUN AVERAGE COST The long-run average cost curve is the relationship between the lowest attainable average total cost and the output when both the plant size and labor are varied.

14. Different Shapes of Long Run Average Cost Curves 1. The Curve LAC in the Panel ’a’ suggests early economies of scale, followed by diseconomies of scale beyond a least cost plant size. 2. The Curve LAC in Panel ‘b’ happens when economies of scale offset diseconomies over a broad range of output. It has a prolonged downward slope till a very large level of output and thereafter, an upward curve. 3. The Curve LAC in Panel ‘c” represents the situation in which a firm initially experiences economies of scale when it expands, represented by the downward sloping portion of LAC curve.

15. LONG RUN TOTAL COST Long run Total Cost (LTC) refers to the minimum cost at which given level of output can be produced.  LTC is always less than or equal to short run total cost, but it is never more than short run cost.

16. LONG RUN MARGINAL COST Long run Marginal Cost (LMC) is defined as added cost of producing an additional unit of a commodity when all inputs are variable. This cost is derived from short run marginal cost. If perpendiculars are drawn from point A, B, and C, respectively; then they would intersect SMC curves at P, Q, and R respectively. By joining P, Q, and R, the LMC curve would be drawn. It should be noted that LMC equals to SMC, when LMC is tangent to the LAC.

17. CONCLUSION The short run cost curves of a firm are the SAVC curve, the AFC curve, the SAC curve and SMC curve. AC Falls when MC < AC. AC is minimum when MC = AC. AC rises when MC > AC.

18. THANK YOU!