Cost Concepts

Session 1
Mrs. Dhanya Anna Kurian
Cost Concept:
• It is used for analyzing the cost of a
project in short and long run.
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)
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
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
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
Marginal Costs

• The additional cost incurred from

producing an additional unit of output:

MC =  TC
 Output
MC =  TVC
 Output
Typical Total Cost Curves

• TVC,TC is always increasing:

– First at a decreasing rate.
– Then at an increasing rate
Typical Average & Marginal Cost
Curves
• AFC is always • MC is generally
declining at a increasing.
decreasing rate. • MC crosses ATC and
• ATC and AVC AVC at their minimum
decline at first, point.
reach a minimum, • If MC is below the average
then increase at value:
higher levels of – Average value will be
output. decreasing.
• The difference • If MC is above the average
value:
between ATC and
– Average value will be
AVC is equal to increasing.
AFC.
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.
Contd…
3.If expected selling price > minimum ATC (which
implies TR > TC):
– A profit can be made.
• Maximize profit by producing where:
MR = MC
Short Run Production Decisions

SP SP
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.
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.
Long Run Cost Curve

Economies of scale Diseconomies of scale

M

M-optimum level of production

Economies of Scale:
• Economies of scale are the cost
advantages that a firm obtains due to
expansion. Diseconomies is the opposite.
Internal
Technical economies/ diseconomies
Managerial economies/ diseconomies
Commercialeconomies/ diseconomies
etc
• External
– Technological
– Development of skilled labour
– Transportation