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					Costs of Production
What factors affect costs
  What do we need to
   consider in costs
Wherever production takes place,
 costs follow. One has to make
 payments for all factors of
 production, i.e. incur certain costs

Cost curves show the minimum cost of
 producing various levels of output
 Explicit vs Implicit cost
• Explicit costs are actual, out of pocket
  expenditures for factors hired or
  purchased e.g. rent.
• Implicit costs are costs of factors owned
  by firm and used in its own production
  process.
  COSTS= EXPLICIT + IMPLICIT

SUNK COSTS
  Time period and costs
Short Run costs
• Total fixed cost (TFC)– cost which firm
  incurs for fixed inputs, whether there is
  output or not. eg. Rent
• Total variable cost (TVC) –cost incurred by
  firm for variable input eg raw material
TOTAL COST = TFC + TVC

Long run costs    All costs are variable
          Numerical
Q   TFC   TVC TC   • Plot in the form of
0   60    0          a graph.
1   60    30
2   60    40       • What is the shape
                     of cost curve
3   60    45
4   60    55
                   • New image 1
5   60    75
6   60    120
FIGURE 6-7 Short-Run Total Cost, Total Variable Cost, and
                  Total Fixed Cost
   Short run units costs
Average fixed costs (AFC)=TFC/output
Average variable costs (AVC)=TVC/output
Average cost =Total cost/output
AC = AVC +AFC
Marginal cost (MC)= change in TC per unit of
  output
(Calculate and Plot all costs on a graph……)
           Fill in blanks
Q    TC    TFC TVC ATC AFC AVC MC
0    125
10                               5
20                    10.5
30              110
40   255
50                           3
60                               3
70                    5
Short run unit costs
Shape of MC,AVC and AC
         curve
• Why are MC, AVC and AC curve U shaped?
• Why does AC reach its lowest point to
  right of point at which AVC curve is
  lowest?
• Why does the MC curve intersect the AVC
  and AC curves at their respective lowest
  point?
          Long Run costs
• In long run, all factors are variable. The firm can
  build a plant of any size.
• The long run average cost (LAC) curve shows the
  minimum per unit cost of producing each level of
  output when any desired scale of plant can be
  built. LAC is given by a curve tangent to all SAC
  curves representing all alternative plant sizes
  that the firm can build in the long run.
• Mathematically, LAC is envelope of SAC curves.
Relationship Between Short-Run Average Cost Curves and the
               Long-Run Average Cost Curve
    Economies of Scale
• Why does LAC fall in beginning
- Economies of scale (Internal vz
  external economy)

- Why does LAC rise eventually
- Diseconomies of scale (internal vz
  external)
Long-Run Average Cost and Returns to Scale
       Learning curves
• As firm gain experience in production
  of a commodity, the average cost of
  production declines. For a given level
  of output, cost per unit decreases.
  the learning curve shows decline in
  average input cost of production with
  rising cumulative total output over
  time.
Estimating and using cost
       functions
• Find minimum total cost function
  given
TC = 1000 + 10 Q _ .9Q² + .04Q³

Find rate of output that results in
  minimum average variable cost
    Profit = Revenue -
               Cost
Revenue concepts = TR, MR, AR

Total Revenue (TR): The sum total of sale
  proceeds from no. of units sold. TR= P.Q
Average Revenue: This is TR/ quantity

Marginal Revenue: This is change in total
 revenue when there is change in quantity
 sold of a product. MRn = TRn – TRn-1.
International applications
  of cost minimisation
• Growing importance of international
  trade i.e. theory of comparative
  advantage
• MNC which have production plants
  throughout the world
International applications
         contd…
• Ability on part of some firms to
  satisfy their needs for some skilled
  labour from abroad

• Brain drain
• Outsourcing trends – bpo, kpo, lpo
  Break even analysis
• The break even point is that
  point of activity (sales volume)
  where total revenue and total
  expenses are equal. It is point of
  zero profit.
1. Breakeven point in units
2. Breakeven point in sales
3. Breakeven point in percentage
Break-Even Analysis
   • At the Break-even point TR =
         but
     TC, TR  TVC  TFC
  or
         P(Q)  AVC(Q)  TFC
                          TFC
   therefore:    QBEP 
                        P  AVC
     (P - AVC) is known as the unit
   contribution margin.
    [1-(AVC/P)] is known as the
   contribution margin ratio and indicates
   the fraction of the price that covers
   fixed cost and profit
    Break even analysis
• S b = TFC
        1- ( TVC/ TR)

% b = TFC                 * 100
      ( P- AVC) * Q (cap)

				
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