Economics - Cost Analysis, Study notes of Economics

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Introduction

 (^) Determinants of Cost Function: C=f (S,O,P,T,M)  (^) The cost of production may be defined as the aggregate of expenditure incurred by the producer in the process of production. Cost, is therefore, the valuation placed on the use of resources.  (^) Several concepts of costs such as; Fixed Cost, Variable Cost, Total Cost Average Cost, Marginal Cost, Money Cost, Real Cost, Implicit Cost, Explicit Cost, Private Cost, Social Cost, Historical Cost, Replacement Cost And Opportunity Cost.  (^) Fixed costs are those costs which remain fixed, irrespective of the output. They have to be incurred on equipment, building etc and they are incurred even when the output is zero. Fixed costs are also called Supplementary costs or Overheads or Indirect costs.  (^) Variable costs are those costs which vary with the output. For example the cost of raw materials, electricity, gas, fuel etc. the Variable costs are also called Prime costs, Direct costs or Operating costs.

Three points that emerge are

Marginal cost changes due to variable cost and hence is independent of fixed cost. Secondly the shape of Marginal Cost is determined by the law of variable proportions. Price of a factor input remains constant is a vital assumption.

The difference between the short-run and long run

production function is based on the distinction between

fixed and variable costs. In the short-run production

function, the output is increased only by employing more

units of variable factors; other factors of production

remaining fixed. In the long run all factors are variable and

thus all costs are variable.

Marginal Product and Marginal Cost: when Marginal

Product is increasing Marginal Cost is decreasing and

when Marginal Product is decreasing MC is increasing.

MC increases in the range where production faces a

diminishing returns.

 Average Cost: The Average Cost is the cost per

unit of output produced. Thus, the Average Cost

is obtained by dividing the total cost by the total

output.

 TC = TFC and TVC.

 AC can be rewritten as

AC = TFC + TVC

Q

Therefore AC= AFC+AVC

AC = TC Q

AVC = TVC

Q

1. In the starting the average variable cost is rather high.
2. When more and more units of output are produced, the firm starts enjoying several advantages in the form of transport, commercial and marketing economies and thus the average variable cost goes on falling.
3. Any further effort to increase the output brings about disadvantages in marketing and other processes involved in production, mainly associated with the employment of variable factors and thus the average variable cost begins to rise.

 The Average Cost Curve in the Short-Run

The AC curve is the lateral summation of the

average fixed and variable cost curves.

AC = AFC + AVC

The average fixed cost curve slopes downwards

from left to right (AFC curve) and average

variable cost curve first goes downwards and then

bends upwards (AVC curve).

Each point of AC curve can be plotted as the sum

of AFC and AVC.

The U-Shape of Average Cost Curve is explained in two

ways :

i) The Geometrical explanation : The shape of AC curve

depends on the slopes of AFC And AVC curves.

Therefore, the AC curve acquires U-shape.

ii) The Theoretical explanation :Economies of Scale

MC AC dQ d AC MC AC dQ d AC MC AC dQ d AC AC measures slope of dQ d AC AC dQ d AC MC Q dQ d AC Q MC dQ d TC MC TC AC Q              0 , ( ) 0 , ( ) 0 , ( ) ( ) ( ) (. ) ( ) . 1.When AC is falling, the MC lies below it

2. Secondly MC cuts the AC at the lowest point of AC curve

3. when AC curves begin to rise, the marginal cost curve will be above the AC curve

 Long- Run Average Cost Curve : Long- Run Average Cost Curve will envelope the related series of all short-run AC curves. In case of short-run since some factors are “Indivisible” the producer has to remain contented by making best use of the given plant; whereas in the long run the scale of operation can be altered and the producer will choose the most feasible plant. There will be a new short run average cost each time the scale is revised.