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COMILLA UNIVERSITY
1. NAZMUN NAHAR 2. MD ALAMIN CHOWDHURY 3. TANIA AFRIN 4. EMDADUL BARI 5. MARJANA AKTER 6.DILARA BEGUM SUBMISSION DATE: APRIL 29, 2008
ROLL 20 06 10 15 25 41
Comilla University
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Salmanpur, Kotbari Comilla-3500. April 29,2008 Mohammed Belal Uddin Lecturer Department of Accounting (BBA Faculty) Comilla University. Dear Sir, We are submitted the report on The Theory of Costs of the subject of Micro Economics. Our effort to present the necessary topics about The Theory of Costs. We have tried to focus all the relevant secession according to the requirement. We have asked to submit the report and we have tried our level best to make the report factual, informative and logical supported by the economist and other respective. We feel encouraging and optimistic if you take if as a simple person for any mistakes on the report.
Sincerely Yours Nazmun Nahar Leader of ....................... group Department of Accounting Comilla University.
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Contents
Part-A
(1)The traditional theory of costs (2) Modern theory of costs
Part-B
1. Definition.
i. Total Cost. ii. Fined Cost. iii. Variable Cost. iv. Average Cost. v. Marginal Cost. vi. The theory of opportunity Cost. 2. Relationship between AK and AVC.
Part-C
1. 2. 3. 4. 5. 6. 7. curve. Short-run. Long-run. Distinguish between short-run & long-run. Characteristics of long average cost curve. Derivation of LPAC curve from SARC curve. i. The average fined cost. ii. The average variable cost. iii. The average total cost. Long-run costs In modern Microeconomic theory: The L-shaped scale
Part-D
1. 2. Recommendation. Bibliography.
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EXECUTIVE SUMMARY
Cost functions are derived functions they are derived from the production function, which describes the available efficient methods of production at any one time. Economic theory distinguishes between short-run and long-run costs. Short-run costs are the costs over a period during which some factors of production are fined the long run costs are the costs over a period long enough to permit the change of all factors of production. In the long-run all factors become variable. The internal economics of scale relate only to the long-run and are built into the shape of the long-run cost curve the external economics affect the position of the cost curves. Both the short-run and the long-run cost curves will shift if external economics affect the prices of the factors or the production function. The traditional theory of costs is U-shaped some recent developments in the theory of costs which reject the strict U-shape of the short-run cost curves on the grounds that its assumptions are not realistic and question the envelop long-run cost curve on the grounds that diseconomies are not a necessary consequence of large-scale operations.
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Part-A
1.
The traditional theory of costs: Traditional theory distinguishes between the short ran and the longrun. The factors is fixed: usually capital equipment and entrepreneurship are considered as fixed in the short run. The long run is period over which all factors become variable.
2.
Modern theory of costs: The U-shaped cost curves of the traditional theory have been questioned by various writers both on theoretical a priori and on empirical grounds. As early as 1939 George Stigler suggested that the short-run average variable cost has a flat stretch over a range of output which reflects the facts in their productive capacity. The reasons in detail by various economists. The shape of the long-run cost curve has attracted greater attention in economic literature, due probably to the serious policy implications of the economics of large scale production. Like, the traditional theory, modern microeconomics distinguishes between short-run and long-run costs.
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PART-B
Total cost: Total cost represents the lowest total expense needed to produce each level of output. Total cost Te Fixed cost of output. e.g. 1. 2. 3. Y Salaries of administrative staff. Depreciation on machinery. Expense for building depreciation and repair. = = : Fixed cost + Variable cost Fe + Vc. Fixed cost is that cost which does not vary with the level
X output Variable cost: Variable cost is the cost which varies with the level of output. e.g.: I) Row materials. ii) Direct labor. iii) Running expense of fixed capital. Y total variable cost
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Y E p
TC
c S O
TFC
At Point C, FC = Oc, Vc = O TC = FD + FD = FD + DC = FE. Marginal cost: Marginal cost is the additional cost resulting in increasing output by one unit produced. Again, the changes in total cost due to the change in output. MC =
d c d q
TFC + TVC
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Unit 1 2 3 4
FC 10 10 10 10
AFC
1 5 1 1 0 1 1 5 1 20
Y Y TVC
cost
X O output X
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AFC O X1 The AVE is a part of ATC Given: ATC = AFC + AVC Both AVC and ATC are U-shaped reflecting the law of variable proportions. However, the minimum point of the ATC occurs to the right of the maximum point of the AVC. This is due to the fact that ATC includes AFC and the latter falls continuously with increases in output. After the AVC has reached its lowest point and starts rising, its rise is over certain range offset by the fall in the AFC, so that the ATC continuous to fail (over that range). Despite the increase in AVC. However, the rise in AVC eventually becomes greater the AVC approaches the ATC asymptotically as x increases. The minimum AVC is reached at x1 while the ATC is at its minimum at x2. Between x1 and x2 the fall in APC more than offsets the rise in AVC so that the ATC continuous to fall. Beyond x2 the increase in AVC is not offset by the fall in AFC. X2 X
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Opportunity cost:
According to this doctrine (opportunity cost) the cost of producing one commodity is used in their best alternative uses.
e.g.
Opportunity gain:
When the benefit acquired from the current employment of resources is greater than benefit receipts from its best alternative use that there is an opportunity gain.
Opportunity loss:
When the benefit acquired from the current employment of resources is than benefit receipts from its best alternative use that there is an opportunity loss.
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Short-run
I) It is a production situation when at least one of the inputs used in production is fixed. i.e. the producer cant increase the amount of such inputs to increase production even when market conditions required that additional output to be produced. In short-run plant size is usually considered as the fixed input. Law of variable proportion is applicable in short-run. The expansion of output with one factor at least constant. I)
Long-run
It is a production situation when all the factors of production are variable. i.e. the producer can increase any of the inputs to increase production is required.
ii)
ii)
iii) iv) v)
iii) iv) v)
Since all factors are variable in long-run, there is fixed cost. Law of return to scale is applicable in long-run. Change in output as all factors changes by the same proportion.
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X O OUTPUT
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The decision at this point depends not on costs but the expectations about its future demand it the firm expects that the demand will expand further than x1 it will install the medium plant, because with this plant outputs larger than x2 are produced with a lower cost. Similar considerations hold for the decision of the firm when it reaches the level x2. If it expects its demand to stay constant at this levels the firm will not install the larger plant, given that it insulates a larger inquestment which s profitable only it demand expands beyond x2. For example, the level of output x3 is produced at a cost c3. With the larger plant, while it costs c2 if produced with the medium size plant.
Average fixed cost: This is the cost of indirect factors such as: 1. 2. 3. 4. 5. 6. Salary & other expenses of administrative staff. Salary of wonders who are fixed to paid. The were & tear of machinery. The expenses of maintenance of buildings. The expenses of maintenance of land on Which the plant is installed and operates.
The business man will choose the size of plant which will allow him to produce level of output more flexibility & efficiently. The plant will have a capacity larger than the expected average level, this is called reserve capacity. The does it for various reasons. Such as: To meet seasonal & cy........ fluctuation. To comply with the increase demand so that It will not so rival. To comply with future growth. To adjust with the technology. To be more flexible in production.
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In summary the businessman will not necessarily choose the plant which will give him today the lowest cost, but rather than equipment which will allow him the greatest possible flexibility. C A B
COST
OX XA OUTPUT XB
Under these conditions the AFC curve is shown in the graph. The firm has some Largest capacity units of machinery which sets an absolute limit to the short run expansion of output. The firm has also small unit machinery which sets a limit to expansion to boundary A. If we shift in short-run to expansion of output we have to pay more cost either by paying over time to direct labor for working longer hours on by buying some additional small plant. So AFC curve shifts upwards and starts falling again.
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Average variable cost: Direct labor which karris with output. Raw materials. Running expenses of machinery.
OUTPUT
In modern theory the SAVC has a source-type shape. It is broadly U shaped but has a flat stretch over a range of output. It is occurred due to reserve capacity. Over this stretch the SAVC is equal to the MC. These both are constant per constant per unit of output. To the left of the stretch, MC lies below the SAVC and opposite to the right of that. The falling close to the better utilization of the fixed factor & increasing skill and productivity of the variable factor. The increasing part of SAVC reflects reduction in labour productivity due to the longer house of work, increasing overtime, the
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wastes of material and more frequent breakdown of machinery. Reserve capacity makes it possible to have constant SAVC with a certain range of output.
Average total cost: The average total cost is obtained by adding the average fixed cost and average variable costs at each level of output. The ATC is shown in the figure. The ATC curve falls continuously up to the level output x4 at which the reserve capacity is exhausted. Beyond that level ATC will start rising. The MC will interest the average total cost curve at its minimum point which occurs to the right of the level of output x4 at which the flat stretch of the AVC ends.
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LAC
Following this procedure, and assuming that the typical load factor of each plant is two thirds of its full capacity, we may draw the LAC curve by joining the points on the SATC curves corresponding to the two thirds of the full capacity of each plant size. If we assume that there is a large number of available plant sizes the LAC curve will be continuous. The characteristic of of this LAC curve is that (a) it does not turn up at very large scales of output; (B)it is not the envelope of the SATC curves, but rather intersects them(at the level of output defined by the typical load factor of each plant). If, as some writers believe, the LAC falls continuously (though smoothly at very large scales of output), the LMC will lie below the LAC at all scales. If there is a minimum optimal scale of plant at which all possible scale economics are reaped(as Bain and other writers have suggested), beyond that scale the LAC remains constant. In this case the LMC lies below the LAC until the minimum optimal scale is reached and coincides with the LAC beyond the level of output.