cost theory change 2

8/7/2019 COST THEORY change 2

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COST THEORY:COST THEORY:

AVERAGE COSTAVERAGE COSTANDAND

MARGINAL COSTMARGINAL COSTPRESENTATION BYPRESENTATION BY1.NEHA RATHORE1.NEHA RATHORE2.VIBHA JAIN2.VIBHA JAIN

3.RASHIKA SHARMA3.RASHIKA SHARMA

4.RENUKA DESHPANDE4.RENUKA DESHPANDE

5.MANI SONI5.MANI SONI6.RAJLAXMI SONI6.RAJLAXMI SONI

7.RAJESHWARI PEPRE7.RAJESHWARI PEPRE

8.ARJUN THAKUR8.ARJUN THAKUR

9.AJAY TIWARI9.AJAY TIWARI


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INTRODUCTION

Cost theory offers an approach tounderstanding the cost of production that

allows firm to determine the level of output

that reap the greatest level of profit at theleast cost

Economists use cost theory to provide aframework for understanding how

individuals and firms allocate resources in

such a way that keeps costs low benefits high


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TYPES OF COSTS

Explicit Cost OR Accounting Cost

Implicit CostsAlternative or Opportunity CostsRelevant CostsIncremental Costs

Sunk Costs are Irrelevant


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1.Explicit Cost OR Accounting CostsActual expenditure of the firm in purchase or hiring inputs

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

3. Opportunity CostsIt refers the cost what the factor could earn its next

best alternative use


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4. Relevant Costs These are costs that are relevant with respect to aparticular decision. A relevant cost for a particular

decision is one that changes if an alternative course ofaction is taken. Relevant costs are also called differentialcosts.

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.


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CURVECURVE

IN SHORT RUNIN SHORT RUN

0

5

10

15

20

25

0 1 2 3 4 5 6

MC

-

In the begining that is from point A

the marginal cost of production falls,

it is true because of increasingretruns.At point B, the cost of production is

minimum. Later the cost increased in

a increasing rate, It is depicted by

point C, it is true because of

diminishing returns.

AB

C


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Fixed And

Variable Costs Fixed

Costs that do not vary with changes in output

VariableCosts associated with variable inputs and do vary with output

Note: Explicit and implicit costs may contain both fixed andvariable 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


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Short-RunShort-Run

Cost FunctionsCost FunctionsTotal Cost = TC

Total Fixed Cost = TFC

Total Variable Cost = TVC

TC = TFC + TVC


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TOTAL COST CURVESTOTAL COST CURVES

IN SHORT-RUNIN SHORT-RUN

COST

TFC curve is parallel to x axis

It is always fixed though output

Increased or decreased.

TVC curve increase in aDecreased Rate and constant

than increase in a increasing

rate.

TC curve is similar to TVC

But it started from TFC not

From o the TVC start from o

origin.

TC

TVC

TFC

OUTPUT


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Functions ForFunctions For

Average Cost AndAverage Cost And

Marginal CostMarginal CostAverage Total Cost = ATC = TC/Q

Average Fixed Cost = AFC = TFC/Q

Average Variable Cost = AVC = TVC/Q

ATC = AFC + AVCMarginal Cost = TC/ Q =

TVC/ Q


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0

2

4

6

8

10

12

14

16

1820

1 2 3 4 5 6 7 8 9

A F

A V

A T

OUTPUT

C

OST

COSTCURVE IN

SHORT RUNThe ATC decreases with an increase in theoutput but at diminishing rate, because the

Numerator of the ratio TFC/output is constant

While the denominator increases

The AVC and ATC first falls, form a bottom

And then rise beyond a certain output level

The AVC remains below the ATC

The AFC never become zero due to this AC

and AVC never intersect

As AFC starts decreasing the gap between AC

And AVC also decreases


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BETWEEN MC and

AVCIn the beginning MC liesbelowAVC it means MCfalls more than AVC..

Where MC intersect AVCthat point is minimumpointof AVC. After thatAVC lies below MC.After intersection MCincreasein a increasingrate it pulls up AVC.

0

1

2

3

4

5

6

7

8

9

1 2 3 4 5 6 7 8 9 10

AC

Line 2

MC

MC

AVC

ALL COSTS


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ALL COSTSCURVE

DURING SHORT-

RUN A, B & C are the least cost points

The ATC decreases with an increase in theoutput but at diminishing rate.The AVC andATC first falls, form a bottom and thenrise beyond a certain output level the AVCremains below the ATC

Marginal cost also fall and rise but at aspeed higher than ATC & AVC and achieveits lowest point before the ATC

At point c AFC cuts the MC where MC is atits minimum

The MC curve cuts the AVC curve &ATCcurve from below at their minimum point and

then rise at increasing rate

OUTPUT/C

OSTAFC AVC ATC MC

0 - - -

1 100 80 180 80

2 50 22 100 20

3 33.3 36.6 70 10

4 25.3 28.7 53.7 6

5 20 27 47 20

6 16.6 29.1 45.8 40

0

20

40

60

80

100

120

140

160

180

200

AF

AV

AT

MC

B

C

L N RUN


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L N RUN

COSTSIn 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


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Long-Run CostLong-Run Cost

functionfunctionLong-Run Total Cost = LRTC

Long-Run Average Total Cost = LRATC =LRTC/Q

Long-Run Marginal Cost = LRMC =

LRTC/ Q


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Average TotalAverage Total

CostCostLong-run average total cost (LRATC):the lowest-cost combination of resources with which eachlevel of output is produced when all resources are

variable.

The long-run average total cost curve gets its shapefrom economies and diseconomies of scale.

A T t lA

T t


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Average TotalAverage Tota

Cost CurveCost Curve

x

Costsper unit

11

50

55

17

60

14 20

Long-run

average total

cost (LRATC)Minimum

efficientlevel ofproduction

ATC falls because

of economies

of scale

ATC is constant

because of constant

returns to scale

ATC rises because

of diseconomies

of scale

Sh f


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Shape ofape o

LRATCLRATC If producing each unit of output becomesless costly there are economies of scale.

If producing each unit of output becomesmore costly there are diseconomies ofscale.

If unit costs remain constant as outputrises there are constant returns to scale.


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Averagetotal cost

C

ostsperu n

it

$6462

60585654

525048

11 12 13 14 15 16 17 18 19 20 Quantity

DiseconomiesDiseconomies

of Scaleof ScaleEconomies

of ScaleDiseconomies

of ScaleConstantreturns

to Scale


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SHORT-RUN AND LONG-SHORT-RUN AND LONG-

RUN AVERAGE TOTALRUN AVERAGE TOTAL

COST CURVECOST CURVE

Each small U-shaped

curve is a SAC curve.

Deriving a long runDer v ng

a ong run

Der v ng a ong runer v ng

a ong run


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fig

B

LRAC

Costs

Output

O

Deriving a long-runDer v ng a ong-runaverage cost curve:average cost curve:

choice of Plant sizechoice of Plant size

Der v ng a ong-runer v ng a ong-runaverage cost curve:average cost curve:

choice of Plant sizechoice of Plant sizeSRAC.0 SRAC.1

SRAC.2 SRAC.3SRAC.4

K

E

M

A C


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MARGINAL COSTMARGINAL COST

CURVECURVE Long-run marginal cost is the incremental

cost incurred by a firm in production whenall inputs are variable. In particular, it isthe extra cost that results as a firmincreases in the scale of operations by notonly adding more workers to a givenfactory but also by building a larger

factory. Long-run marginal cost is guided by scaleof economies and returns to scale


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MARGINAL COSTMARGINAL COST

CURVECURVE The long-run marginal cost curve is extremelyimportant 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 marginalrevenue 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 marginalcost is not attributable to just one or two variable

inputs, but to all inputs.


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LAC AND LMCLAC AND LMC

Long-run AverageCost (LRAC) curve

isU-shaped.

the envelope of allthe short-run average costcurves;

drivenbyeconomies and diseconomies ofsize.

Long-run MarginalCost (LRMC)curve

Also U-shaped;

intersects LAC at LACsminimumpoint.

RELATIONSHIPRELATIONSHIP


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RELATIONSHIPRELATIONSHIP

BETWEENBETWEEN

LMC AND LACLMC AND LAC

The only difference between long-run and short

run AC and MC is that long-run marginal costcurve and average cost curve are more flatterthan that of SAC and SMC

In long-run marginal cost is not attributable to

just one or two variable inputs, but to all inputs.


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fig

OutputO

Costs

--average andaverage and

marginal costsmarginal costs

-average andaverage and

marginal costsmarginal costsLRMC

LRAC

Economies of scaleand increasing

returns to scale ,

Diseconomies of scale

or marginal returns

to scale

cost theory change 2

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