ECONOMICS

CHAPTER 8: COST AND REVENUE ANALYSIS

Class: XII(ISC)
2017-2018
Q1) Define the following:
i. Money cost
Money cost refers to money expenses which the firm has to incur in purchasing or hiring factor
services. It is also known as Explicit or Accounting Cost.
These expenses include expenditures on wages paid to labour, on machinery and equipment.
ii. Implicit cost
Implicit cost refers to the imputed or estimated value of inputs owned by the firm and used by it in
its own production unit
Eg- The entrepreneur may use his own land and may provide managerial services.
iii. Normal profit
Normal profit is the minimum payment which a producer must get in order to induce him to undertake
the risk of production.
iv. Economic cost
Economic cost is the sum total of both explicit and implicit cost including normal profit.
Economic cost= Explicit cost + Implicit cost (including normal profit).
v. Opportunity cost
The opportunity cost of producing any good is the next best alternative good that is given to produce
this good. E.g. if a given amount of resources can produce 1 meter of cloth or 20 loaves of bread,
then the cost of 1 meter of cloth is 20 loaves of bread which need to be sacrificed in order to produce
1 meter of cloth.
vi. Real cost
Real cost refers to the efforts and sacrifices made by the owners of factors of production used in the
production of a commodity. E.g pain, sacrifice, discomfort and disutility involved in providing
service to produce goods and services.
vii. Private cost: Private cost refers to the cost of production incurred by an individual in producing
a commodity.
viii. External cost
External cost is the cost that is not borne by the firm, but is incurred by other members of the society
or the entire society.e.g pollution
ix. Social cost
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Social cost on the other hand, refers to the cost that the society has to bear on account of the
production of a commodity.
Social cost= Private cost + External cost
x. Total fixed cost
Total fixed cost refers to the cost incurred by the firm on the use of all fixed factors, those factors. It
does not change with output. E.g interest on capital invested, rent, machinery, etc.
xi. Total variable cost
Total variable cost refers to the total cost incurred by a firm on the use of variable factors, those inputs
whose amounts can be varied (changed) in the short run according to production requirements. Hence
these costs change with change in output. Eg payments for raw materials, fuel, power, transportation,
etc.
xii. Total cost
Total cost is the cost incurred on all types of inputs- fixed as well as variable inputs- incurred in
producing a given amount of output.
TC= TFC + TVC
Since total cost has total variable cost has one of the components which varies with a change in
output, the total cost will also change directly with the change in output.
xiii. TFC Curve
TFC curve is a straight line parallel to the horizontal axis indicating the same amount of fixed cost at
every level of output.
xiv. TVC curve
The TVC curve is concave downward up to a point indicating that it increases at a decreasing rate
and subsequently it is concave upward indicating that total variable cost increases at an increasing
rate. TVC increases at a diminishing rate due to increasing returns to the variable inputs arising from
the fuller utilization of fixed factors and greater specialization. It increases at an increasing rate due
to diminishing returns to the variable inputs arising from difficulty of management and overutilization
of fixed factors.

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Explain the behavior of average cost curves of a firm in the short – run.
xv. Average fixed cost is the per unit cost of the fixed factors.
AFC= TFC
Q
It slopes downward throughout its length from left to right showing continuous fall in average fixed
cost with an increase in output.
The curve is asymptotic to the axes. The curve approaches X- axis but never touches it because
average fixed cost cannot be zero, since the total fixed cost is positive.
xvi. Average variable cost
Average variable cost is the per unit cost of the variable factors of production.
AVC= TVC
Q

The U-shape of the AVC follows directly from the law of variable proportions. Initially, the quantity
of variable input increases, fixed input is better utilized, resulting in an increase in the efficiency of
the variable factors. Efficiency of variable input increases also because of specialization and division
of labour. Therefore, the AVC curve is negatively sloped Subsequently, however, as the quantity of
variable input goes on increasing, the variable input becomes too much in relation to the fixed inputs
the fixed input has been fully utilized. In short, the average variable cost falls up to the level of output
due to increasing returns to the variable factor and it increases thereafter die to diminishing returns
to the variable factor.
xvii. Average total cost
Average total cost is the per unit cost of both fixed and variable factors of production.
ATC= TC
Q
ATC= AVC + AFC
xviii. Marginal cost
Marginal cost is the addition to total cost as one more unit of output is produced.
MCn= TCn – TCn-1
MC= ∆TC

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 ∆Q

xix. Relationship between average and marginal cost

 When marginal cost is less than the average cost, average cost falls with an increase in output.
 When marginal cost is greater than the average cost, average cost is rising.
 When marginal cost is equal to average cost, the average cost is constant.

Define Total Revenue, Average revenue, Marginal Revenue

Total Revenue: refers to the total amount of income received by the firm from selling a given amount
of its output. TR = P x Q
Where TR is total revenue, P is price per unit, Q is quantity of output sold over some time period.
e.g if a firm sells 15 units of a product at Rs 20 per unit, he total revenue is 20x15 = 300.
Average revenue: is the revenue per unit of the product sold. It is total revenue divided by the number
of units of the product sold
AR = TR / Q =PxQ / Q =P
e.g If TR is Rs300 and 15 units are sold. AR = 300 / 15 = 20.

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Marginal Revenue: is defined as the addition to total revenue which results from the sale of one
additional unit of output. MR n = TRn – TR n-1
e.g. Total revenue is Rs 300 units for sale of 15 units and Total revenue is Rs 304 for the sale of 16
units. MR is 304-300 = 4.

Explain the behavior of Total, Average and Marginal Revenue under Perfect Competition.

Relationship between AR and MR

When price remains same at all output, no firm is in a position to influence the market price of the
product. A firm can sell more quantity of output at the same price. It means, the revenue from every
additional unit (MR) is equal to AR. As a result, both AR and MR curves coincide in a horizontal
straight line parallel to the X-axis as shown in Fig above

Relationship between TR and MR

When price remains constant, firms can sell any quantity of output at the price fixed by the market.
As a result, MR curve (and AR curve) is a horizontal straight line parallel to the X-axis. Since MR
remains constant, TR also increases at a constant rate. Due to this reason, the TR curve is a
positively sloped straight line.

Explain the behavior of Total, Average and Marginal Revenue under Imperfect Competition.
A firm under imperfect competition is required to reduce the price if it wants to sell more output.
Total Revenue will increases initially, but at a diminishing rate, with increase in output, reaches the
maximum and remains constant at that level and then starts falling. This is because the producer
under imperfect competition as it increases output, it must reduce the price more and more to sell
additional output and this causes an increase in the total revenue to get smaller. As price falls to very
low levels, the total revenue actually falls.

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Average Revenue falls continuously as output increases, because a firm is required to reduce the price
to sell more.
Relationship between Total revenue and Marginal revenue under imperfect competition
1. When TR is increasing MR is falling but is positive.
2. When TR will be maximum when MR is zero.
3. When TR will fall when MR is negative

Relationship between Average revenue and Marginal revenue under imperfect competition
1. So long as the AR curve is falling, marginal revenue must be less than average revenue for
every level of output (except for the first level where it is equal.
2. When AR is a straight line, MR is also a straight line but the rate of fall of MR will be twice
as much as the rate of fall of AR.

Extra questions:
1. Solve numerical problems based on cost and revenue.
2. What is shape of MC curve?
3. Why distance between ATC and AVC reduces as output increase.
4. Distinguish between Fixed cost and Variable cost.

INSTRUCTIONS TO STUDY THIS CHAPTER:

 Please read your book for detailed information of the above topics.
 The length of the answer depends on the marks in the question paper and may not only be
substituted with what is mentioned in the notes.
 Examples can be used to elaborate your points for this chapter.
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