DIT SCHOOL OF BUSINESS PRESENTATION ON SHORT RUN & LONG RUN COST CURVES

PRESENTED BY :SAJU THOMAS SARANSH ANAND ROHAN SINGH

Cost:Sum of the inputs may multiplied by their respective prices and added together give the money value of the inputs, that is the cost of production.

TYPES OF COST
y Opportunity and actual cost y Explicit and implicit cost y Out of pocket and book cost y Fixed, variable and marginal cost y Short term and long term cost y Incremental and sunk cost y Historical cost and replacement cost y Private and social cost

Opportunity cost and actual cost

y Opportunity cost It may be defined as the expected returns

form the second best use of the resources which are forgone due to the scarcity of resources. y Actual cost The total money expenses recording in the books of accounts.

Business cost and Full cost

Business cost Business cost include all the expenses which are incurred to carry out a business. Full cost It includes business cost ,opportunity and normal profit.

Explicit cost and Implicit cost

y Explicit cost Explicit cost are those cost which fall under

actual or business costs entered in the books of accounts. y Implicit cost Implicit cost do not take the form of cash outlays

Out of pocket cost and Book cost

y Out of pocket cost The items of expenditure which involve

cash payments or cash transfer are known as out of pocket costs. y Book cost Book cost which are entered in the books of accounts

Fixed cost and variable cost

y Fixed cost Fixed cost are those which are fixed in volume

for a certain given output/scale of production. y Variable cost Variable cost are those which vary according to the level of production.

y Marginal cost It is the addition to total cost due to the addition of one y y

y y

unit of output. Short run cost short run cost are those cost which vary according to the variation in output Incremental cost -It arises due to change in scale of production, introduction of a new product and replacement of a worn out plant and machinery. Sunk cost sunk cost are those cost which can not be changed. Historical cost It includes all the past expenditure incurred for the production of goods and services.

y Replacement cost It refers to the outlay which has to be made for

replacing an old asset.

y Private cost private cost are those which are incurred by an

individual/firm on the purchase of goods and services from the market. y Private cost =explicit cost +implicit cost y Social cost it is the total cost borne by the society due to production of a commodity.

Short run cost function:y The short run is defined as a period of time in which output of a

firm can be increased or decreased by changing the amt of variable factors such as labour , raw materials , chemicals , fuel etc
y Total fixed & variable cost in the short run:y Total Fixed cost :y Fixed cost are those which are independent of output , ie they do not

change with changes in output. Even if the firm closes down for some time in the short run but remains in business these costs have to be borne by it. y EXAMPLE:- charges such as contractual rent , insurance fee , maintenance cost , property tax, interest on the borrowed funds etc.

Total Variable cost:y Variable costs are those costs which are incurred on the employment

of variable factors of production whose amt. can be altered in the short run. Thus, the total variable cost change with changes in output in short run, i.e. they increase or decrease when the output rises or falls. y EXAMPLE: it includes payment to labour employed , the prices of the raw material , fuel & power used etc.

TC = TFC+TVC

Table :-

The short run average & marginal cost curves:y Average fixed cost:y Average fixed cost is the total fixed cost divided by the no. of

units of output produced . Therefore,

AFC=TFC / Q
y Avg. fixed cost curve slops downward throughout its length but it

doesn't touch the x axis . y As output increases , the total fixed cost spreads over more & more units & therefore avg. fixed cost becomes less & less.

Average variable cost:y Average variable cost is the total variable cost divided by the no.

of units of output produced. Therefore,

AVC= TVC / Q The average variable cost is variable cost per unit of output .

Average total cost:-

y The average total cost or what is called simply average cost is the total

cost divided by the number of unit of output produced. y Thus,

Average total cost = total cost/ output

The marginal cost curve (MC)

y A marginal cost that graphically represents the relation between

marginal cost incurred by a firm in the short-run product of a good or service and the quantity of output produced. This curve is constructed to capture the relation between marginal cost and the level of output, holding other variables, like technology and resource prices, constant. The marginal cost curve is U-shaped. Marginal cost is relatively high at small quantities of output, then as production increases, declines, reaches a minimum value, then rises. The marginal cost is shown in relation to marginal revenue, the incremental amount of sales that an additional product or service will bring to the firm. This shape of the marginal cost curve is directly attributable to increasing, then decreasing marginal returns (and the law of diminishing marginal returns - Diminishing returns). Marginal cost equal w/MPL. For most production processes the marginal product of labor initially rises, reaches a maximum value and then continuously falls as production increases. Thus marginal cost initially falls, reaches a minimum value and then increases.

Theory of long run cost:y The long run refers to a time period during which full

adjustment to a change in environment can be made by the firm by varying all inputs , including capital equipment & factory building. y Long run avg. cost curve :The long run as noted above is period of time during which the firm can vary all its inputs. The long run production function has therefore no fixed factors & the firm has no fixed cost in the long run. In the short run, some inputs are fixed & others are varied to increase the level of output .while in the long run none of the factors is fixed and all can be varied to expand output.

The LR Relationship Between Production and Cost

y In the long run, all inputs are variable.
y What makes up LRAC?

The Long-Run Cost Function :y Reasons for Economies of Scale

y Use of technically efficient machine y Division of labour y Invisibility & economies of scale y Financial economy y Economies of scope.

The Long-Run Cost Function :y Reasons for Diseconomies of Scale

 Decreasing returns to scale  Input market imperfections  Management coordination and control problems

THANK YOU