detailed explanation of cost concepts in micro economics....

1. Cost Concepts

2. Cost Concept:
 It is used for analyzing the cost of a
project in short and long run.

3. Types of Cost:
 Total fixed costs (TFC)
 Average fixed costs (AFC)
 Total variable costs (TVC)
 Average variable cost (AVC)
 Total cost (TC)
 Average total cost (ATC)
 Marginal cost (MC)

4. Fixed Costs(FC)
Fixed Cost denotes the costs which do not
vary with the level of production. FC is
independent of output.
Eg: Depreciation, Interest Rate, Rent, Taxes
 Total fixed cost (TFC):
All costs associated with the fixed input.
 Average fixed cost per unit of output:
AFC = TFC /Output

5. Variable Costs(VC)
Variable Costs is the rest of total cost, the part that
varies as you produce more or less. It depends
on Output.
Eg: Increase of output with labour.
 Total variable cost (TVC):
All costs associated with the variable
input.
 Average variable cost- cost per unit of output:
AVC = TVC/ Output

6. Total costs(TC)
The sum of total fixed costs and
total variable costs:
TC = TFC +
TVC
Average Total Cost
Average total cost per unit of output:
ATC =AFC + AVC
ATC = TC/ Output

7. Marginal Costs
 The additional cost incurred from
producing an additional unit of output:
MC = ∆ TC
∆ Output
MC = ∆ TVC
∆ Output

8. Typical Total Cost Curves
 TVC,TC is always increasing:
 First at a decreasing rate.
 Then at an increasing rate

9. Typical Average & Marginal Cost
Curves

10.  AFC is always  MC is generally
declining at a increasing.
decreasing rate.  MC crosses ATC and
 ATC and AVC decline AVC at their minimum
at first, reach a point.
minimum, then  If MC is below the average
increase at higher value:
levels of output.  Average value will be
 The difference decreasing.
between ATC and AVC  If MC is above the average
value:
is equal to AFC.
 Average value will be
increasing.

11. Production Rules for the Short-Run
1.If expected selling price < minimum AVC (which
implies TR < TVC):
 A loss cannot be avoided.
 Minimize loss by not producing.
 The loss will be equal to TFC.
2.If expected selling price < minimum ATC but >
minimum AVC:
(which implies TR > TVC but < TC)
 A loss cannot be avoided.
 Minimize loss by producing where MR = MC.
 The loss will be between 0 and TFC.

12. Contd…
3.If expected selling price > minimum ATC (which
implies TR > TC):
 A profit can be made.
 Maximize profit by producing where:
MR = MC

13. Short Run Production Decisions
SP SP

14. Long Run Costs Curve:
 All costs are variable in the long run.
 There is only AVC in LR, since all factors
are variable.
 It is also called as Planning Curve or
Envelope or scale curve.

15. Production Rules for the Long-Run
1.If selling price > ATC (or TR > TC):
 Continue to produce.
 Maximize profit by producing where
MR = MC.
2.If selling price < ATC (or TR < TC):
 There will be a continual loss.
 Sell the fixed assets to eliminate fixed costs.
 Reinvest money is a more profitable
alternative.

16. Long Run Cost Curve
Economies of scale Diseconomies of scale
M
M-optimum level of production

17. Economies of Scale:
 Economies of scale are the cost
advantages that a firm obtains due to
expansion. Diseconomies is the opposite.
 Two types:
1. Pecuniary Economies of Scale:
Paying low prices because of buying
in large Quantity.

18. 2.Real Economies of Scale:
Refers to reduction in physical
quantities of input , per unit of output
when the size of the firm increases, as a
result input cost minimized.

19. Diseconomies:
1.Internal Economies: It is a condition
which brings about a decrease in LRAC of
the firm because of changes happening
within the firm.
e.g.As a company's scope increases, it may
have to distribute its goods and services in
progressively more dispersed areas. This
can actually increase average costs
resulting in diseconomies of scale.

20. 2.External Economies:
It is a condition which brings about a
decrease in LRAC of the firm because of
changes happening outside the firm.
E.g. Taxation policies of Gov…