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AMITY GLOBAL

BUSINESS SCHOOL Chandigarh


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Economics
Indu Grewal

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Types of Cost
Opportunity cost
Explicit cost
Implicit cost
Total cost
Average cost
Marginal cost
Incremental cost
Sunk cost
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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.

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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

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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

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VC
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Relation between TC FC &VC
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AC
AC = AFC + AVC
AFC = TFC / O/P
AVC = TVC / O/P
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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
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AFC
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AVC
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All Short run cost curves in one Diagram
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Marginal Cost
MC = Change in TC
Change in O/p
MC
COST
O/P
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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
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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)
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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
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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
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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
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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

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