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Meaning The costs which involve outflow of cash due The costs in which there is no cash outlay, is
to the use of factors of production is known known as Implicit Cost.
as Explicit Cost.
Which profit can be calculated with the help Accounting Profit and Economic Profit Economic Profit
of cost?
Example Salaries, rent, advertisement, wages, etc. Interest on owner's capital, Salary to owner,
rent of owner's building, etc. which do not
occur in reality.
COST FUNCTION
Accounting profit
= total revenue minus total explicit costs
Economic profit
= total revenue minus total costs (including explicit and
implicit costs)
Accounting profit ignores implicit costs,
so it’s higher than economic profit.
Normal profit(zero economic profit)
The accounting profit just sufficient to ensure that all
resources used by the firm earn their opportunity cost
Any accounting profit in excess of a normal profit is
economic profit
Economist’s Accountant’s
View View
Economic
Profit Accounting
Profit
Implicit
Revenue Costs
Revenue
Economic
Costs
Explicit Explicit
Costs Costs
CLASS TASK -
22
Calculus corner:
For minimum AC:
First order condition (FOC)
Second Order Condition
d AC/dQ = O (SOC)
Or, d (TC/Q)/dQ = O d2AC/dQ2 > O
Or, QdTC/dQ - TC = O Slope of MC > Slope of AC
MC cuts AC from below.
Q2
Or, QMC-TC =O
Q2
Or, QMC-TC=O
Or, MC=TC/Q
Or, MC=AC
From the given data find out, TVC
AVC AFC AC MC (given that TFC=60)
Units- 0 1 2 3 4 5 6
TC(Rs.)- 60 90 100 105 115 135 180
Q.2 From the data regarding a firm’s production
department, calculate i) AC ii) AVC iii)AFC
No. of units produced 200
No. of workers employed 50
Monthly wage of each worker 300
Rent 300
Cost of raw material 2000
Fuel consumption 400
Cost Elasticities & Economies of
Scale
It is very often easy to calculate scale economies by
considering cost elasticities.
Ec = Percentage change in TC/ Percentage change in
output
= TC/ TC Q/Q
= TC/Q x Q/TC
Cost elasticity is related to
economies of scale as follows:
If
i) Percentage change in TC< Percentage change in Q,
Ec<1 : Economies of scale (decreasing AC)
ii) Percentage change in TC = Percentage change in Q,
Ec=1 : No economies of scale(constant AC)
iii) Percentage change in TC> Percentage change in Q,
Ec>1 : Diseconomies of scale (increasing AC)
An inverse relation exists between Ec and
economies of scale, while a direct relation exists
between Ec and diseconomies of scale.
Output Elasticities & Economies
of Scale
It is very often easy to calculate scale economies by
considering output elasticity also.
Ec = Percentage change in output/ Percentage change
in input
= Q/ Q I/I
= Q/I x I/Q
Output elasticity is related to
economies of scale as follows:
If
i)Percentage change in TQ> Percentage change in Input (I),
Eq>1 : Increasing returns to scale,as ouput increases at a faster
rate than input usage.
ii) Percentage change in TQ = Percentage change in I,
Eq=1 : No effect of scale
iii)Percentage change in TQ<Percentage change in I,
Eq<1 : Decreasing returns to scale, as output increases slowly
than the usage of inputs
A direct relation exists between Eq and returns to scale.
Costs in long run-
• All costs are variable in the long run since the factor
endowments are variable.
• It implies radical changes in the cost structure of a
firm.
• The long run cost function is referred to as the
planning cost function.
• LAC curve is known as the planning curve.
• Since the long run consists of many short runs, the
cost curve is a composite of many short run cost
curves.
It arises with lower AC of manufacturing a product when two complementary
products are produced by a single firm.
Measuring Economies of Scope
For a firm producing say three products / activities,
If we assume that the individual costs of these
activities are- C1 ,C2 , C3 & Ct is the total cost of all
activities taken together
the Scope Index (S) can be measured as-
S= (C1 + C2 + C3 – C t )
C1 + C2 + C3
If S is positive , it is better to carry these three activities in the same plant
If S is negative, it is better to execute them separately.
ECONOMIES OF SCALE