Cost_Output_Relationship (1).pptx for bcom bba and mba

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1. Cost–Output Relationship in Short Run & Long Run Including Cost Curves, Economies and Diseconomies of Scale Prepared for Classroom Teaching

2. Meaning of Cost • Cost of production refers to total money expenditure incurred in producing output. • Includes Explicit Costs (cash expenses) and Implicit Costs (opportunity costs). • Helps in pricing and profitability decisions.

3. Cost–Output Relationship • Explains how production cost changes as output changes. • Differs in the Short Run (some inputs fixed) and Long Run (all inputs variable).

4. Short Run: Nature of Costs • Fixed Costs (TFC): Constant regardless of output (rent, salaries). • Variable Costs (TVC): Change with output (wages, materials). • Total Cost (TC) = TFC + TVC.

5. Short Run Cost Curves • AFC (Average Fixed Cost) = TFC/Q → Downward sloping. • AVC (Average Variable Cost) = TVC/Q → U-shaped. • AC = TC/Q → U-shaped due to AFC + AVC. • MC = ΔTC/ΔQ → U-shaped; intersects AC & AVC at their minima.

6. Diagram: Short Run Cost Curves • The U-shaped curves arise due to the Law of Variable Proportions. • MC falls first, then rises. • AC and AVC follow the same pattern; AFC continuously falls.

7. Long Run: Nature of Costs • All inputs are variable – no fixed cost. • Firms can change plant size and production scale. • Governed by the Law of Returns to Scale.

8. Long Run Cost Curves • Long Run Average Cost (LAC): Shows minimum possible cost per unit at different output levels. • Envelope Curve: Tangent to each Short Run AC. • Long Run Marginal Cost (LMC): Intersects LAC at its minimum point.

9. Economies of Scale (Falling LAC) Internal Economies: • Technical – Specialization and advanced machinery. • Managerial – Efficient supervision. • Financial – Easy loans, lower rates. • Marketing – Bulk buying/selling. • Risk-bearing – Diversification reduces risk. External Economies: • Industry-level benefits: infrastructure, skilled labor, suppliers.

10. Diseconomies of Scale (Rising LAC) • Managerial: Poor coordination in large firms. • Communication: Delays and bureaucracy. • Resource Constraints: Scarcity increases cost. • External Diseconomies: Industry congestion, higher input prices.

11. Shape of Long Run Average Cost Curve • Falling part – Economies of Scale. • Flat part – Constant Returns to Scale. • Rising part – Diseconomies of Scale. Thus, LAC is typically U-shaped.

12. Comparison: Short Run vs Long Run Short Run: • Some factors fixed. • Law of Variable Proportions. • AFC, AVC, AC, MC curves. Long Run: • All factors variable. • Returns to Scale. • LAC and LMC curves. • Realization of Economies of Scale.

13. Summary and Key Points • Short run cost curves are U-shaped due to variable proportions. • Long run cost curves are U-shaped due to scale economies. • Economies reduce cost; diseconomies raise it. • Firms operate at the minimum point of LAC for efficiency.

14. Discussion Questions 1. Why are short-run cost curves U-shaped? 2. How does the LAC act as an envelope of SACs? 3. What are key differences between internal and external economies? 4. Why do diseconomies occur in large firms?