Cost Theory in the short run and in the long run.pptx

This is about cost theory in the short run

1. Cost Theory Chapter 6 Instructor: Tural Gojayev Azerbaijan University 2020-2021 ECONOMICS OF ENTERPRISE

2. Cost of production In order to produce a good , every firm, makes uses of factor of production . The amount spent on the use of factor of production is called cost of production . Cost of production mainly depend upon quantity of production . Ordinarily , cost of production increases with increases in output . It can therefore be said that cost of production is a function of quantity C = f(Q)

3. Explicit cost and Implicit cost . An explicit cost is a direct payment made to others in the course of running a business. For example : bills ; -Wages paid to workers ; - Pay material mon . It refers to opportunity cost of resources already owned by the firm and used in business. For example: - Giving workers a day off – will lead to a drop in sales and income - Rent for self owed property Payments of electricity ment of raw Explicit cost Implicit cost

4. Theories of cost T r a ditional theory Mo d e r n theory

5. Traditional Theory of Cost Under traditional theory, cost are studied in two parts on the basis of time-period: (i) Cost in short run (ii) Cost in the long run . Cost are mainly of three types : 1. Total Cost 2. Average Cost 3.Marginal Cost

6. Cost in the short-run The amount of money spent on the production of different levels of a good is called total cost . * Total Fixed Costs Fixed cost are costs which do not change with change in the quantity of output . For e . g . ? TC=TFC+TVC

7. Total fixed cost Units of output Total fixed cost 10 1 10 2 10 3 10 4 10 5 10 6 10 TFC C o st Units of Output

8. 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 rises these costs also rise. 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. Relation between Total , Fixed and Variable sts Co Output TFC TVC TC 10 10 1 10 10 20 2 10 18 28 3 10 24 34 4 10 28 38 5 10 32 42 6 10 38 48 7 10 46 56

10. AVERAGE COST 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

11. Average Fixed Cost Average fixed cost is equal to total fixed cost divided by output ; i.e., AFC=TFC/Q 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

12. Average variable cost Average variable cost is total variable cost divided by output . That is , AVC=TVC/Q

13. OUTPUT TVC 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

14. 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 :

15. 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

16. Relationship b/w AC & MC 1. Both AC & MC are calculated from TC 2. AC= C/Q M C= T C/ Q OUTPUT T TC AC MC 1 20 20 20 2 28 14 8 3 34 11.3 6 4 38 9.5 4 5 42 8.4 4 6 48 8 6 7 56 8 8 8 72 9 16

17. 3. MC cuts AC from its lowest point 4. When AC rises MC also rises

18. 5. When AC becomes constant MC becomes equal to AC 6. When AC falls MC also falls and AC > MC

19. 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 long- run 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 ,na m ely , (1)Long-run to t al cost ( L T C ) , (2)Long-run average cost (LAC) , (3)Long-run marginal cost(LMC) .

20. 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.

21. Long Run Average Cost The Long Run Average Cost, LRAC, curve of a 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).

22. Long - run marginal cost 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, a long - run concept, rather than the law of diminishing marginal returns, which is a short- run concept.

23. Modern theory of cost curves Modern theory of cost curves has been propounded by economists like Stigler , Andrews etc . According to traditional theory of cost curves , cost curves are U-shaped . But according to modern theory , in real life , cost curves are L-shaped .

24. Modern Theory of Average Fixed Cost

25. Average Variable Cost

26. Short run Average Cost Curve

27. Modern Theory of Long run Cost Curve

28. Long run Marginal Cost Curve