THEORY OF COSTS

COST OF PRODUCTION : In order to produce a good , every firm , makes use of factor of production . The amount spent on the use of production is called cost of production. Cost of production mainly depends on quantity of production .Cost of production mainly depends on quantity of production. Ordinarily , cost of production increases with increase in output. C = f (Q)

EXPLICIT

COSTS

• All those expenses that a firm incurs to make payment to others is called explicit costs. In the words of LEFTWITCH,”Explicit costs are cash payments which firms make to outsiders for their services and goods.

IMPLICIT

COSTS

• These are the costs of an entrepreneur’s own factors or resources. In the words of LEFTWITCH,” Implicit costs are costs of self – owned and self – employed resources.”

OPPORTUNITY COST: Modern economists attach great importance to the concept of opportunity costs. This concept was first introduced by D.I. GREEN in his article ,” Pain cost and opportunity cost” published in 1894., but credit for making it popular goes to PROF. KNIGHT. According to this concept , in an economy , supply of economic resources is limited , relative to their demand.

DEFINATION : In the words of LEFTWITCH , “Opportunity cost of a particular product is the value of the foregone alternative products that resources used in its production , could have produced.”

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COST OF PRODUCTION

(1) TOTAL FIXED COSTS OR SUPPLEMENTARY COSTS: In the short period ,costs of fixed factors are called fixed costs . According to ANATOL MURAD, “Fixed costs are costs which do not change with change in the quantity of output.” These costs do not change with change in the quantity of output. Production may be maximum or of zero unit, fixed costs remain same. Fixed costs include the following expenditure:

RENT DEPRECIATION SALARY OF ADMINISTRATIVE STAFF INTERST ON FIXED CAPITAL NORMAL PROFIT

(1) TOTAL COST: The amount of money spent on the production of different levels of a good is called total cost. If a total sum of Rs.2000 is spent on the production

of 5000 exercise books ,then the total cost of 5000 exercise book will be Rs.2000. In the words of DOOLEY, “Total cost of production is the sum of all expenditure

incurred in producing a given volume of output.” In the short period, total costs are composed of two costs.

TC = TFC + TVC

QUANTITY OF OUTPUT

FIXED COST (Rs.)0

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FIXED COSTS

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UNITS OF OUTPUT

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FIXED COST

(2) TOTAL VARIABLE COSTS OR PRIME COSTS : Variable costs are those costs which are incurred on the use of variable factors of production. According to DOOLEY, “Variable cost is one which varies as the level of output varies.” These costs undergo a change with change in output. If output is fall these cost also fall to zero. Rate of increase in these costs is determined by the law of variable proportions.Variable cost include :

EXPENSES ON RAW MATERIALS WAGES OF LABOUR WEAR AND TEAR EXPENSESELECTRICITY CHARGES

VARIABLE COSTS

OUTPUTVARIABLE COSTS (Rs.)

CHANGE IN VARIABLE COSTS

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AVERAGE COST : Per unit cost of goods is called its average cost. In the words of FERGUSON, “Average cost is total cost divided by output.” AC = TC/QIn the words of DOOLEY, “The average cost of production is the total cost per unit of output.”

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(1)AVERAGE FIXED COST : Average fixed cost equals to total fixed cost divided by output .

AFC = TFC/Q

AVERAGE FIXED COST

OUTPUT FIXED COST (Rs.)

AVERAGE FIXED COST (Rs.)1

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(2) AVERAGE VARIABLE COST : Average variable cost is total variable cost divided by output. That is,

AVC = TVC/QAVERAGE VARIABLE COST

OUTPUT TOTAL VARIABLE COST (Rs.)

AVERAGE VARIABLE COST (Rs.)

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6.46.36.67.8