Cost output relationship

economics

1. COST Output Relationship It may be noted at the outset that, in cost ac­counting, we adopt functional classification of cost. But in economics we adopt a different type of clas­sification, viz., behavioural classification-cost beha­viour is related to output changes. The theory of cost deals with the behaviour of cost in relation to change in output. In other words, the cost theory deals with the cost output relationship.

2. Cost Theory In Short Run The basic principle of the cost behaviour is that the total cost increases with the increase in output. But the specific form of cost function depends on whether the time framework chosen for cost analysis is short – run or long – run. It is important to know that some costs remains constant in the short run while all costs are variable in the long run.

3. Short run Short run is the period wherein only some of the factors are held constant and some are variable. Therefore, the costs associated with both fixed and variable inputs form part of the short period costs. Short – Run Total Cost: TC = TFC + TVC The costs which are found in the short period: 1) Total Fixed Cost 2) Total Variable Cost 3) Total Cost 4) Average Cost : a) Average Variable Cost b) Average Fixed Cost c) Average Total Cost 5) Marginal Cost

4. Total Fixed Costs Fixed cost are costs which do not change with change in the quantity of output . For eg .- Salary to permanent Staff - Licensce fee.

5. Unit Of Output Total Fixed Cost 10 1 10 2 10 3 10 4 10 5 10 6 10

6. cost unit of output

7. Total variable cost Variable cost is one which varies as the level of output varies. If output falls these cost also falls and if output increases rises these costs also rise .

8. Unit of output Total variable cost Change in total variable cost 1 10 10 2 18 8 3 24 6 4 28 4 5 32 4 6 38 6

9. Total Average C ost Per unit cost of a good is called its average cost . AC=TC/Q   Average cost is composed of two types of costs in the short period : (i) Average fixed cost (ii) Average variable cost AC=AFC+AVC

10. Average cost Average fixed cost Average fixed cost is equal to total fixed cost divided by output ; i.e., AFC=TFC/Q Average variable cost Average variable cost is total variable cost divided by output . That is , AVC=TVC/Q

11. Output TFC AFC 1 10 10 2 10 5 3 10 3.3 4 10 2.5 5 10 2 6 10 1.7 7 10 1.4 Output TFC AVC 1 10 10 2 18 9 3 24 8 4 28 7 5 32 6.4 6 38 6.3 7 46 6.6 8 62 7.8

12. Marginal cost Addition made to the total cost by the production of one more unit of a commodity is called marginal cost . Its formula is : MCn =TCn-TCn-1 OR

13. Output TC MC - 1 20 20-0=20 2 28 28-20=8 3 34 34-28=6 4 38 38-34=4 5 42 42-38=4 6 48 48-42=6 7 56 56-48=8

14. Costs in the Long-Run Each firm operates under short-run production conditions , but it formulates long-run production plans . In order to know about the production plans of a firm , it becomes essential to study longrun cost . No cost is fixed in long-run . All costs becomes variable costs in this period . As in the case of short-run , there are 3 concepts of costs in the long-run also ,namely , (1)Long-run total cost(LTC) , (2)Long-run average cost (LAC) , (3)Long-run marginal cost(LMC) .

15. Long Run Total Cost * The long run total cost curve shows the total cost of a firm’s optimal choice combinations for labor and capital as the firm’s total output increases. * Note that the total cost curve will always be zero when Q=0 because in the long run a firm is free to vary all of its inputs

16. Long Run A verage C ost The Long Run Average Cost, LRAC , curve of firm shows the minimum or lowest average total cost at which a firm can produce any given level of output in the long run (when all inputs are variable).

17. Long Run M arginal C ost LRMC is the minimum increase in total cost associated with an increase of one unit of output when all inputs are variable. The long-run marginal cost curve is shaped by returns to scale , along-run concept, rather than the law of diminishing marginal returns, which is a shortrun concept .