Cost Analysis

Introduction
Before understand the all cost concept we should have to understand the meaning
of cost. Cost is normally considers from the producer’s or firm’s point of view. For the
production of any commodity producers are using the help of many things, we called
factors of production and that is land, labour, capital and entrepreneur. Producer should
have to give reward to these factors. So to land pays rent, to labour pays wages, to capital
pays interest and profit to the entrepreneur. And other important thing is that other
expenses for the produce the commodity if it is there for the production like raw material,
and any other cost. Other concept is also there like cost is the total expense before selling
the product without adding the profit.
In short cost is the amount paid to the factors of the production. In other simple
word we can say cost is the total expense to produce any commodity or product.

Various Cost Concepts

Every firm wants to maximize their profit or minimize losses they have to
consider two things.
(1) Increase the price of the product
(2) Decrease the Cost of the product
Price can be change in only one way but cost is difficult because all cost has not a
same kind of nature. So there is a need to understand the nature of the cost. As per the
nature of the cost there are different cost concept derived. It is helpful to understand the
cost and as per their nature producers can control over the cost and they can minimize the
cost.

Money Cost:
Money cost means the aggregate money expenditure incurred by a firm for the
production of the commodity. For example wages, salary, rent, interest etc. if any
expense occurred but is not calculated in term of money, that cost should not consider as
a money cost.

Real Cost:
The real cost means the cost of real work or efforts involved directly or indirectly
in the production of the commodity. In other word we can say real cost is money cost
plus extra efforts for the production of commodity. It can be in term of money or it can
not be. As per Prof Marshall real cost is “The exertions of all the different kind of
labour that are directly or indirectly involved in making it; together with the abstinence or
rather the waiting required for saving the capital used in making it, all these efforts and
sacrifices together will be called the real costs of production of that commodity.”

Opportunity Cost
The opportunity cost of any commodity is the best alternative commodity that is
sacrificed of foregone. For example Money is used for the production of the car could be
used for the production of any other product like machinery or bike or scooter etc.
 Note: if in exam question ask for this and if its more than 3 marks you should
write its limitation also it is the book (elements of economics by R C Joshi, page no. 133)

Short run and Long run

The short run is a period of time in which output can be increased or decreased by
changing only the amount of variable factors such as labour, raw materials etc. In the
short run, quantities of fixed factors such as capital equipment, factory buildings, top
management etc.
Long run is a period of the time on which quantities of all factors – fixed as well
as variable can be changed. Thus in the long run, output can be changed not using more
quantities of labour and raw materials but also by expanding the size of capital equipment
or buildings new plant with larger production capacity.

Fixed Cost
Fixed costs are those items of expenditure which are not affected with output of
the production. They do not change with the change in output. If there is zero production
but that cost is occurred. But in long run it can be changed. In simple word fixed cost is
fixed and it is not change with the output.
For example:
Rent for the building.
Interest on loan
Depreciation on machineries
Salary
Insurance premiums
Property and business tax (note: not write WAT and sales tax here)

From the
above
diagram
we can

understand the fixed cost

To X axis the output and to Y axis Fixed cost is there.
 FF is the fixed cost curve it is parallel to X axis because fixed cost remain
unchanged with out put. When output A, B or C it is same.
As we know the term sort run and long run. Fixed cost remains same in the short
run but in long run all cost can be changed so fixed costs are not fixed permanently. To
increase the production in long run firm will have to increase its plant, to purchase new
machinery etc.

Variable Cost
Variable costs are those cost which very or change with output. So if output is
zero the cost is zero and if output increased the cost will be increased.
Variable costs are also known as direct cost which can be changed in short run as
output changes. For example:
Cost of raw materials
Wages of labour
Power
Excise, sales tax
Transport etc/

In this diagram OV is the Variable cost curve. You can see at the point O it is zero
and as the output increases the cost also increases. At OA level it is AE, OB level it is BF
and OC level it is CG.

Semi-variable Costs
Semi-variable costs are those cost which is not totally fixed or not variable. It is
partly fixed and partly variable.
For example
Telephone Bill (rent fixed and charges per call)
Electricity Bill etc.
 Total Cost
Total cost is the sum total of fixed cost and Variable cost.
Total Cost = Total Fixed Cost + Total Variable Cost
TC= TFC+TVC

In this diagram , the total cost curve TC has been obtained by adding total fixed cost
curve (TFC) and total variable cost curve (TVC) because total cost means total of fixed
and variable cost. As said earlier TC=TFC+TVC

Relation Between Marginal Cost and Average Fixed Cost, Average Variable Cost
and Average Total Cost.

The relation between Marginal Cost and Average Fixed Cost, Average Variable Cost and
Average Total Cost shall be clear from a study of the following diagram.
From the above diagram we can clarify following points to explain the relationship
between Marginal Cost and Average Fixed Cost, Average Variable Cost and Average
Total Cost.
(1) There are four curves in the diagram. MC is the marginal cost curve, ATC is
the Average Total Cost curve, AVC is the Average Variable Cost curve and
AFC is the Average Fixed Cost curve.
(2) A is the point where MC curve cuts the AVC and B is the point where MC
curve cuts the ATC.
(3) Average Fixed cost curve (AFC) is a downward sloping curve in the shape
rectangular hyperbola. Because as the out put increases the average cost
decreases. It will never touch the Y axis because average always calculated
with at least one unit. And it will never touch X axis because average fixed
cost can not be zero.
(4) Average Variable Cost curve (AVC) at first falls and then rises because as we
know at the starting of any business it is not utilized 100% capacity so up to
normal capacity is it falls down and then it starts to increase the curve.
(5) Average Total Cost curve (ATC) which is the sum total of Average fixed cost
and average variable cost curves is a U shaped curve.
(6) Marginal Cost curve (MC), after showing an initial fall it rises continuously
thereafter. The curve is same like AVC but its little different.
(7) Between Average fixed cost curve and Marginal cost curve there is no clear
relationship because as we know that Marginal cost always change with the
Variable cost in short run but in long run all cost is a variable so we can say
in short if there is a fixed cost no relationship with the marginal cost.
(8) And there is a relationship with the average variable cost curve (AVC) and
average total cost curve (ATC). We can see in the diagram point A where
marginal cost curve (MC) cuts the AVC and point B where MC cuts the ATC.
Where lowest point of both the curves.
In short we can say there is a clear relationship with between Marginal Cost and Average
Variable cost and Marginal Cost and Average Total Cost, and no definite relationship
between Marginal Cost and Average fixed Cost.