COST OF

PRODUCTION
BY:
DEVYANI
PRACHI
NIDHI
ANISHA
ASHISH
Cost
Function
Cost functions are derived from the production
function, which describes the technically
efficient method of producing a commodity at
any one time.
The time factor is very important in cost theory.


Symbolically short run cost function is:

 c = f (X, T, Pf, Ќ)
Long run cost function is:
 c = f(X, T, Pf)
 OPPORTUNITY COST:
Opportunity cost or alternative cost is the cost
of alternative opportunity sacrificed or given
up.
It arises because resources are scarce and they
have alternative uses.

 ECONOMIC COST vs ACCOUNTING
COST:
Economic cost is the cost to a firm of utilizing
economic resources in production, including
opportunity cost.
Accounting cost is the actual expense plus
depreciation charges for capital equipment.

 EXPLICIT COST vs IMPLICIT COST
EXPLICIT

COST IMPLICIT COST
1. It includes actual money 1. It is not the actual money
expenditure incurred by a firm in expenditure but is the cost of
hiring or buying the factors it factors owned by the firm and
needs in the production process. used by the firm in its
production process.
2. It is a payment concept. 

2. It is a receiptconcept, i.e., the

payments are received by
producer for self supplied
3. Eg: wages, rent, interest, services.
insurance, etc.
3. Eg: wages for self, rent for
self owned premises, etc.



PRIVATE COST vs SOCIAL COST


Private cost is money cost incurred by a firm in

producing a commodity
Social cost is cost of producing a commodity to
the society as a whole. It includes real cost
which is borne by the society, directly or
indirectly, due to produced commodity.
SHORT-RUN COST vs LONG-RUN COST


Short-run costs are the costs over a period

during which some factors are fixed in supply,
like plant, machinery etc.
Long-run costs are the costs over a period long
enough to permit changes in all factors of
production.
 FIXED COST vs VARIABLE COST

FIXED COST (FC) VARIABLE COST (VC)
FC is incurred on fixed factors VC is incurred on variable
of production like machines, factors of production like labor,
land, etc.not change with change raw
FC does material,with
VC changes etc change in
in level of output. level of output.
FC cannot be changed during VC can be changed during
short-run. short-run.
FC is never zero even when VC is zero when production
production is stopped. stops.
Production at the loss of FC Production at the loss of VC
may continues. will not continue.
COSTS IN SHORT-
RUN
There are three types of cost:

1.Total cost
2.
3.Average cost
4.
5.Marginal cost

TOTAL COST
The total cost of production(TC) is divided into
two parts, name total fixed cost(TFC) and
total variable cost(TVC).
 TC = TFC + TVC
TC
TOTAL FIXED COST
Fixed cost is defined as the cost which does not
vary with the output, eg: depreciation of
machinery, land, salaries/wages etc.
In the short-run, at least one input is fixed and
its price constitutes the fixed cost.
 C

TFC

O
X
TOTAL VARIABLE COST
Variable cost is that varies with the quantity of
output produced.
It includes cost of direct labor, cost of raw
materials and running expenses.
C
TVC

O
X
AVERAGE COST
Average cost is easily obtained as :
 TC = TFC + TVC
 TC = TFC + TVC
 X X X
 AC = AFC + AVC
Where, X = level of output
 AC = average cost
 AFC = average fixed cost
 AVC = average variable cost.

 AVERAGE FIXED COST
TFC is constant and spreads out over more
and more units, so AFC becomes lesser
and lesser.
When output becomes large it approaches
zero but never becomes Zero and touches
to X-axis.
AFC curve falls continuously, as more units
are being produced.


AFC
AVERAGE VARIABLE COST


As output rises, AVC falls initially because of

increasing returns .
Beyond the optimum capacity, AVC will rise
steeply because of the operation of diminishing
returns .
AVC is ‘U’ shaped because initially it falls as the
productivity of variable input increases, reaches
at minimum when the plant is operated and
start rising beyond that point. AVC

O
Relationship between AC, AFC &


AVC


ATC depends upon AVC and AFC.

Initially AVC and AFC are high at low levels of
output.
As level of output increases in the initial
stages, ATC falls Sharply as both AFC and AVC
Curves fall.
When AVC curve begins to rise, AFC still
continues to fall.
ATC curve continues to falls because the fall in
AFC curve out weighs the rise in AVC curve.
Therefore , the minimum point of ATC is
reached for a large output than the minimum
point of AVC curve.
Relationship between AC , AFC &
AVC .
C
ATC

AVC

AFC

O X
MARGINAL COST
Marginal cost is defined as addition made to
the TC or the TVC as output is increased by
one more unit.
MC curve is also U-shape.


MC
Relation between AC & MC


● W h e n A C fa lls w ith in cre a se in O u tp u t, M C is

lo w e r th a n A C a n d it lie s b e lo w th e A C .
● A s lo n g a s M C fa lls it lo w e rs th e A C o f p ro d u ctio n .
● W h e n M C exce e d s A C it re su ltin g rise in A C
b e ca u se o f rise in TC .
● W h e n M C in te rse cts A C it is th e m in im u m p o in t
of A C .

COSTS IN LONG-
RUN
In the long-run, all variable. There no fixed
factors and no fixed costs.
There are 3 types of costs in long-run :


1.Long-run total cost (LTC)

2.Long-run average cost (LAC)
3.Long-run marginal cost (LMC)
LONG-RUN AVERAGE
COST
The LAC shows the average cost of production
when all factors are in variable supply.
It shows the minimum per unit cost of
producing each level of output when the
capacity of the firm can be varied.
The LAC curve is derived from short-run AC
(SAC) curves.
LAC curve is a curve tangent to all the SAC
curves.
Long-run average cost
curve – ‘Envelope curve’
Y
SAC7
SAC1

SAC6
SAC2 LAC

SAC3

I K
SAC4
SAC5

O M N P X
Features of LAC
The reason behind the u-shape of LAC is the
laws of returns to scale.
LAC curve is called an envelope curve because
no part of SAC curve can ever be below the
LAC curve, this is because there is no reserve
capacity.
LAC is the planning curve because if the firm
plans to produce output X at minimum cost
then LAC curve helps in deciding that the
most appropriate plant size would be the
lowest SAC.
Shifts in cost
curves


Change in input supply.


Change in technology.
THANK
YOU