COST THEORY:

AVERAGE COST
AND
MARGINAL COST PRESENTATION BY
1.NEHA RATHORE
2.VIBHA JAIN
3.RASHIKA SHARMA
4.RENUKA DESHPANDE
5.MANI SONI
6.RAJLAXMI SONI
7.RAJESHWARI PEPRE
8.ARJUN THAKUR
9.AJAY TIWARI
INTRODUCTION
Cost theory offers an approach to
understanding the cost of production that
allows firm to determine the level of output
that reap the greatest level of profit at the
least cost
Economists use cost theory to provide a
framework for understanding how
individuals and firms allocate resources in
such a way that keeps costs low benefits high
TYPES OF COSTS
Explicit Cost OR Accounting Cost
Implicit Costs
Alternative or Opportunity Costs
Relevant Costs
Incremental Costs
Sunk Costs are Irrelevant
1.Explicit Cost OR Accounting Costs
Actual expenditure of the firm in purchase or hiring inputs

2.Implicit Costs
Costs charged to inputs that are owned by firm

3. Opportunity Costs
It refers the cost what the factor could earn its next
best alternative use
4. Relevant Costs
These are costs that are relevant with respect to a
particular decision. A relevant cost for a particular
decision is one that changes if an alternative course of
action is taken. Relevant costs are also called differential
costs. 

5. Incremental Costs
The increase or decrease in costs as a result of one more
or one less unit of output

6. Sunk Costs are Irrelevant

Sunk costs are costs that cannot be recovered once they
have been incurred.
 COSTS
DURING
SHORT-RUN
• FIXED COST

• VARIABLE COST
 MARGINAL COST
CURVE
IN SHORT RUN
In the begining that is from point A

25 the marginal cost of production falls,

it is true because of increasing
20
retruns.
At point B, the cost of production is
15 MCminimum. Later the cost increased in
C
-
10 a increasing rate, It is depicted by
A point C, it is true because of
5
B diminishing returns.
0
0 1 2 3 4 5 6
 Fixed And
Variable Costs
• Fixed
Costs that do not vary with changes in output
• Variable
Costs associated with variable inputs and do vary with output
• Note: Explicit and implicit costs may contain both fixed and
variable costs
– Variable
• Explicit: electricity to run machine, cans for beer.
• Implicit: cost of time owner spends overseeing workers.
– Fixed
• Explicit: long term lease on machinery
• Implicit: cost of not selling a new technology invented for production
• Total cost (TC) = fixed + variable
 Short-Run
Cost Functions
Total Cost = TC
Total Fixed Cost = TFC
Total Variable Cost = TVC
TC = TFC + TVC
 TOTAL COST CURVES
IN SHORT-RUN TFC curve is parallel to x axis
It is always fixed though output
Increased or decreased.
TC
TVC curve increase in a
Decreased Rate and constant
C
O than increase in a increasing
S TVC
rate.
T

TFC
TC curve is similar to TVC
But it started from TFC not
From o the TVC start from o
origin.
OUTPUT
 AND MARGINAL
COST
• Average cost - It is the total cost divided by no.
of Goods and units produced

• Marginal cost- It is the increase in total cost that

results from increasing

production by one unit of
output
 Short-Run Cost
Functions For
Average Cost And
Marginal Cost
Average Total Cost = ATC = TC/Q
Average Fixed Cost = AFC = TFC/Q
Average Variable Cost = AVC = TVC/Q
ATC = AFC + AVC
Marginal Cost = ∆ TC/∆ Q =
∆ TVC/∆ Q
 COST CURVE IN
20
SHORT RUN
18 The ATC decreases with an increase in the
16 output but at diminishing rate, because the
14 Numerator of the ratio TFC/output is constant
While the denominator increases
C 12 AFC
O 10 A VThe
C AVC and ATC first falls, form a bottom
S 8 And then rise beyond a certain output level
AT C
T
6 The AVC remains below the ATC
4
The AFC never become zero due to this AC
2 and AVC never intersect
0
As AFC starts decreasing the gap between AC
1 2 3 4 5 6 7 8 9 And AVC also decreases
OUTPUT
 BETWEEN MC and
AVC
9
MC In the beginning MC lies below
8 AVC
AVC it means MC
7
falls more than AVC..
6 AC
5 Line 2
Where MC intersect AVC
4 MC
that point is minimum
3
point of AVC. After that
2 AVC lies below MC.
1
0 After intersection MC increase
1 2 3 4 5 6 7 8 9 10 in a increasing
rate it pulls up AVC.
 ALL COSTS OUTPUT/C
OST
AFC AVC ATC MC

CURVE 0
1 100
-
80 180
- -
80

DURING SHORT- 2
3 33.3
50 22
36.6
100
70
20
10

RUN 4
5
25.3
20
28.7

27
53.7
47
6
20

 A, B & C are the least cost points 6 16.6 29.1 45.8 40

 The ATC decreases with an increase in the

output but at diminishing rate.The AVC and 200
ATC first falls, form a bottom and then
rise beyond a certain output level the AVC 180
remains below the ATC
160
 Marginal cost also fall and rise but at a
speed higher than ATC & AVC and achieve 140
its lowest point before the ATC AFC
 At point c AFC cuts the MC where MC is at 120
its minimum AVC
100
 The MC curve cuts the AVC curve &ATC
ATC
curve from below at their minimum point and 80
then rise at increasing rate
A MC
60 B
40 C
20
0
 LONG RUN
COSTS
In long run all inputs are variable ,
Because costs that are fixed in the short run can
be changed if the planning horizon of producer is
long enough.
Accordingly ,there are no TFC and AFC curves in
the long run and the concept of marginal cost
remains exactly the
Long-Run Cost
function
Long-Run Total Cost = LRTC
Long-Run Average Total Cost = LRATC =
LRTC/Q
Long-Run Marginal Cost = LRMC =
∆ LRTC/∆ Q
 Average Total
Cost
Long-run average total cost (LRATC): the lowest-
cost combination of resources with which each
level of output is produced when all resources are
variable.

The long-run average total cost curve gets its shape

from economies and diseconomies of scale.
 Average Total
Costs
Cost Curve
per unit
60
Long-run
Minimum
average total
efficient cost (LRATC)
55 level of
production

50

x
11 14 17 20
ATC falls because ATC is constant ATC rises because
of economies because of constant of diseconomies
of scale returns to scale of scale
 Shape of
LRATC
– If producing each unit of output becomes
less costly there are economies of scale.
– If producing each unit of output becomes
more costly there are diseconomies of
scale.
– If unit costs remain constant as output
rises there are constant returns to scale.
 Diseconomies
of Scale
$64 Economies Constant Diseconomies
62 of Scale returns of Scale
60 to Scale
Costs per unit

Average
58 total cost
56
54
52
50
48
11 12 13 14 15 16 17 18 19 20 Quantity
RELATIONSHIP BETWEEN
SHORT-RUN AND LONG-
RUN AVERAGE TOTAL
COST CURVE

Each small U-shaped

curve is a SAC curve.
 Deriving a long-run
average cost curve:
choice of Plant size
SRAC.0 SRAC.4
SRAC.1
SRAC.2 SRAC.3

K
M
LRAC
Costs

O A B C
Output fig
 LONG –RUN
MARGINAL COST
CURVE
• Long-run marginal cost is the incremental
cost incurred by a firm in production when
all inputs are variable. In particular, it is
the extra cost that results as a firm
increases in the scale of operations by not
only adding more workers to a given
factory but also by building a larger
factory.
• Long-run marginal cost is guided by scale
of economies and returns to scale
 LONG –RUN
MARGINAL COST
CURVE
• The long-run marginal cost curve is extremely
important to the long-run profit maximization of a
firm. In the same way that a firm maximizes
economic profit in the short run by equating marginal
revenue with (short-run) marginal cost, a firm
maximizes economic profit in the long run by
equating marginal revenue with long-run marginal
cost. The key difference is that long-run marginal
cost is not attributable to just one or two variable
inputs, but to all inputs.
 Long-run Average Cost (LRAC) curve

–
is U-shaped.
the en velope of al l the short-run average c ost c urves;
driven by ec onomies an d disec onomies of size.
Long-run Marginal Cost (LRM C) curve
Al so U-shaped;
intersec ts LAC at LA C’ s min imum poin t.
LAC AND LMC
• –
–

–
• –
 RELATIONSHIP
BETWEEN
LMC AND LAC
• The only difference between long-run and short
–run AC and MC is that long-run marginal cost
curve and average cost curve are more flatter
than that of SAC and SMC
• In long-run marginal cost is not attributable to
just one or two variable inputs, but to all inputs.
 Long-run
average and
marginal costs LRMC

LRAC
Costs

Economies of scale Diseconomies of scale

and increasing or marginal returns
returns to scale , to scale

O Output fig
Initial economies of scale, then diseconomies of scale