COST CURVES

Introduction
The amount spent on the use of factor and non factor
inputs, inputs is called cost of production.

Cost Function. The relation between output and cost is
cost function. Cost functions are derived functions. These
are derived from the production function. Enables the firm
to determine its profit maximizing or loss minimizing
output. Helps a firm in deciding whether it is profitable for
it to continue production. Aids in estimating its profit
both per unit as well as total.
Concepts of Cost/Types of Cost.

Money cost. The amount spent in terms of money for
production of a commodity is called money cost. Money
cost includes the following expenses. (i) Wages paid to
labourers (ii) Interest on Loans (iii) Rent paid for
premises (iv) Expenditure on raw materials and
machinery (v) Insurance (vi) Taxes (vii) Payments for
power, light, fuel. (viii) Transportation charges.
Real Cost
The mental and physical efforts and sacrifices
undergone with a view to producing
commodity are its real cost. Concept of real
cost is a subjective concept (changing from
person to person)



Accounting Cost or Business cost
Accounting cost refer to cash payments which firms
make for factor (land, labour, Capital) and non-
factor inputs (Advertising), Depreciation and other
booking entries.

Opportunity cost
Cost of next best alternative use.
Opportunity cost is the cost of any activity
measured in terms of the value of the next
best alternative forgone (that is not
chosen).


Importance of Opportunity Cost
The concept of opportunity cost serves as a useful
economic tool in analyzing optimum resource
allocation and rational decision making.

Determination of relative price of Goods. Is useful in
explaining the determination of relative prices of
different goods.
Determination of Normal Remuneration to a Factor.
Sets the value of a productive factor for its best
alternative use. (Attrition)
Decision Making and Efficient Resource Allocation.
The concept of opportunity cost is essential for
rational decision making by the producer. (Smart =
profit oriented)

Limitations.

Those factors which have only specific use have
zero opportunity cost.
Assumes the perfect mobility of the factors
(language is not same every where)
Assumes all factors of production are
homogeneous.(all laborers are not alike)
To calculate accurate opportunity cost is
difficult job.

Economic Cost.
Economic cost includes both accounting costs and
opportunity costs of self owned and self employed resources.
Economic cost differs from accounting cost because it
includes opportunity cost.

Ex:- If attending college has a direct cost of Rs.20,000 a year
for four years, and the lost wages from not working during
that period equals Rs.25,000 a year, then the total economic
cost of going to college would be Rs.180,000 (Rs.20,000 x 4
years + the interest of Rs.20,000 for 4 years + Rs.25,000 x 4
years). The accounting cost of attending college includes
tuition, room and board, books, food, and other incidental
expenditures while there. The opportunity cost of college also
includes the salary or wage that otherwise could be earning
during the period



Social Cost.
Social cost is the total cost to society for an
economic activity (Pollution) Spend more on
laundry, health, medical treatment.

Private Cost. Private cost is the cost incurred
by an individual form for producing a
commodity. It includes both the explicit cost as
well as implicit cost.

Explicit Cost. The monetary payment which a
firm makes to those outsiders who supply
labour, services, material, fuel, transportation
services. Also called absolute costs or outlay
costs or actual costs

Implicit Cost. Many inputs are self owned and
self employed by the firm, the firm does not have
to make any payment for them to anyone. It
gives up the opportunity to receive payment
from someone else to whom it could rent the
building.

Actual Costs, Business Costs and Full Costs.
Actual cost. Includes all contractual payments made in
money like labour, raw material, fuel, transport.
Business Costs. Actual costs, amount of depreciation on
plant, machinery, fixed assets.
Full Costs. Actual costs, depreciation, implicit cost,
normal profits minimum profit s necessary for the firm
to remain in business.

Direct Costs and Indirect Costs. Costs which can be
directly attributed to the production of a unit of a given
product, like labour, raw materials machine hours are
direct costs, this can easily be separated, to a unit of output.
Also known as Traceable or Assignable costs. Indirect costs
are those costs which can not be easily separated like fuel,
power, office expenses, and depreciation. Also called Indirect
or overhead or untraceable or un-assignable costs.

Incremental Costs and Sunk Costs. Incremental costs
are the added costs of a change in the level of production by
adding a new product/machinery/system.
Sunk Cost are those which are once
incurred and will not be altered by the change in business
activity. Cost incurred in constructing a factory.



Historical Costs and Replacement Costs. Is the cost of
an asset purchased in the past at the then prevailing price.
Replacement cost is defined as the
cost to be incurred for replacing the same asset at current
level.
Past Cost and Future Costs
Past Costs. are those costs incurred in the past.
These costs are mentioned in the financial
accounts.

Future cost are those which are to be incurred
in the near future and management can evaluate
the desirability of that expenditure.

Out-of-Pocket and Book Costs. Out of pocket
costs are those expenses which are current cash
payments to outsiders. Book costs are those
business costs which do not involve any cash
payments but for them a provision is made in the
books of accounts.(depreciation, interest on
owners capital)


Controllable and Uncontrollable
Costs

Controllable costs are those costs which are
regulated by executive vigilance. Non
controllable Costs are subject to
administrative control and supervision. Most
costs are controllable except obsolescence and
depreciation

Urgent and Postponable costs
Urgent costs are those with out which
production activity would come to a stand still.

Postponable Cost. Painting of factory
building

Shut down and Abandonment Costs.
Shutdown costs are those which the firm incurs
if it temporarily stops its operations.

Abandonment Costs retiring the fixed asset
altogether (war time factories)

Escapable and Inescapable Costs
Escapable Costs discontinue sale of products to
wholesalers.

Inescapable Costs are costs which cannot be
avoided at all. (Room mate cost)

SHORT RUN COST FUNCTION
In the short-run the firm cannot change or
modify overhead factors such as plant,
equipment and scale of its organization. In the
short-run output can be increased or decreased
by changing the variable inputs like labour, raw
material, etc.
costs of production are segmented into fixed and
variable costs. On the other hand, in the long-
run all factors can be adjusted. Hence, in the
long run all costs are variable and none are
fixed.

1) Total Cost: Fixed and Variable

The total cost (TC) of the firm is a function of
output (q). It will increase with the increase in
output, that is, it varies directly with the output.
In symbols, it can be written as

TC = (q)

Since the output is produced by fixed and
variable factors, the total cost can be
divided into two components: total fixed
cost (TFC) and total variable cost (TVC).


TC = TFC + TVC

Fixed Cost
Fixed costs are those which are independent of
output. They must be paid even if the firm
produces no output. They will not change even if
output changes. They remain fixed whether
output is large or small. Fixed costs are also
called 'overhead costs', 'sunk costs' or
'supplementary costs'. They comprise payments
such as rent, interest, insurance, depreciation
charges, maintenance costs, property taxes,
administrative expense like managers salary
and so on. In the short period, the total amount
of these fixed costs will not increase or decrease
when the volume of the firms output rises or
falls