AMITY GLOBAL

BUSINESS SCHOOL Chandigarh

1
Economics
Indu Grewal

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
2
Types of Cost
Opportunity cost
Explicit cost
Implicit cost
Total cost
Average cost
Marginal cost
Incremental cost
Sunk cost
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
3
Opportunity cost :It can be defined as the value of next best alternative.
Explicit cost :Acc to Left witch Explicit costs are those cash payments which
firms make to outsiders for their goods & services.
Implicit costs :Acc to left witch Implicit costs are costs of self owned & self
employed resources.
Total cost : Acc to Dooley Total cost of production is the sum of all
expenditure incurred in producing a given volume of Output.
TC=FC+VC
Average cost :Acc to FergusonAC is TC divided by Output.
AC=AFC+AVC
Marginal cost: It refers to change in TC due to the production of one more or
one less unit.
Incremental cost: Total additional cost associated with the decisions to
expand the output as a whole.
Sunk cost :Which are made once and for all & can't be altered,increased or
decreased by changing the rate of output, nor can they be recovered.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
4
The total cost function can be represented as follows:
TC = TVC + TFC.
For any firm the fixed costs generally include the
following:
salaries of administrative staff,
depreciation of machinery,
expenses incurred for building depreciation and repairs,
expenses for land maintenance and depreciation (if any),
etc.
Another element that can be treated as a fixed cost is
the normal profit, which is a lump sum, including a
percentage return on fixed capital and allowance of risk

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
5
Number of
workers
employed

Total output
(pairs of
running shoes
per week)

Fixed
cost

Variable
cost

Total cost





(Rs.)

(Rs.)

(Rs.)

0

0

500

0

500

1

7

500

300

800

2

18

500

600

1,100

3

33

500

900

1,400

4

46

500

1,200

1,700

5

55

500

1,500

2,000

6

60

500

1,800

2,300

7

63

500

2,100

2,600

8

65

500

2,400

2,900

9

66

500

2,700

3,200

10

66

500

3,000

3,500

11

64

500

3,300

3,800

12

60

500

3,600

4,100

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
6
VC
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
7
Relation between TC FC &VC
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
8
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
9
AC
AC = AFC + AVC
AFC = TFC / O/P
AVC = TVC / O/P
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
10
Total
O/P
Average fixed cost
(Rs.)
Average variable cost
(Rs.)
Average
cost
7 71.43 42.86 114.29
18 27.78 33.33 61.11
33 15.15 27.27 42.42
46 10.87 26.09 39.96
55 9.09 27.27 36.36
60 8.33 30 38.33
63 7.94 33.33 41.27
65 7.69 36.92 44.61
66 7.57 40.91 48.48
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
11
AFC
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
12
AVC
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
13
All Short run cost curves in one Diagram
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
14
Marginal Cost
MC = Change in TC
Change in O/p
MC
COST
O/P
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
15
Short Run Cost Functions
The cost O/p relations are determined by the cost Fn
and are shown through cost curves.
Cost Fns are dervied from actual data of Firms.
Cost Fns may take different forms:
1. Linear
2. Quadratic
3. Cubic
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
16
Linear Cost Function
It takes the following form
TC = a + b Q
where in TC = Total Cost, , a = FC
b = Change in VC due to change in Q, Q = Qty. produced
Given the cost Fn AC & MC can be obtained as follows:
AC = TC = a + bQ = a + b = FC + b = AFC + b
Q Q Q Q
MC = Change in TC = b ( Constant)
Change in Qty.
MC remains const. throughout in case of Linear Cost Fn (
Because b is constant)
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
17
Example
An actual Cost Fn is
given as
TC = 60 + 10 Q
Given this cost Fn one
can easily workout
TC, FC, VC, MC, AC
for diff. levels of Qty
and make a table.

O/p
TFC
= 60
VC =
10 Q
TC =
60+10
Q MC AC
1 60 10 70 10 70
2 60 20 80 10 40
3 60 30 90 10 30
4 60 40 100 10 25
5 60 50 110 10 22
6 60 60 120 10 20
7 60 70 130 10 18
8 60 80 140 10 17
9 60 90 150 10 16
10 60 100 160 10 16
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
18
Quadratic Cost Fn
Its in the form
TC = a + bQ + Q
2
TC = total Cost, a & b constant, Q = O/p
Given this cost Fn AC & MC can be obtained
AC = TC = a + bQ + Q
2
= a + b + Q
Q Q Q
MC = Change in TC = b + 2Q
Change in Qty
Let the actual Cost Fn given as
TC = 50 + 5 Q + Q
2
AC = 50 + Q + 5
Q
MC = Change in TC = 5 + 2 Q
Change in Q
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
19
Cubic Cost Fn
TC = a + bQ c Q
2
+ Q
3
a,b,c = parametric constants
AC = TC = a + bQ c Q
2
+ Q
3
Q Q
MC = Change in TC = b 2cQ + 3 Q
2
Change in Q
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
20

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
21

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
22
A firm's cost curves are linked to
its product curves.
Over the range of rising marginal
product, marginal cost is falling.
When marginal product is a
maximum, marginal cost is a
minimum.
Over the range of rising average
product, average variable cost is
falling.
When average product is a
maximum, average variable cost
is a minimum.
Over the range of diminishing
marginal product, marginal cost is
rising.
And over the range of diminishing
average product, average
variable cost is rising

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
23

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
24