Cost & Price-Difference

Economists

try to use language precisely. The words cost and price are often confused. When we discuss costs we mean, how much did something cost to produce. This might be expressed as an opportunity cost, or in a currency such as dollars or rupees. When price is mentioned, economists mean the amount the consumer pays.

Accounting and economic Costs

Accounting

Costs :Includes explicit Costs only. Cost actually incurred expenditure of a firm. Ex: Raw material cost, power charges,Insurance premiums,Taxes. Economic Costs :Includes both explicit and implicit cost. Ex :Owners own resources used in business Wages of labour rendered by entrepreneur,Rent on land .

Cost Concepts
and Past Costs Incremental and Sunk Costs Out-of-Pocket and Book Costs Replacement and Historical Costs Explicit Costs and Implicit or Imputed Costs (Accounting Concept of Cost and Economic Concept of Cost) Actual Costs and Opportunity Costs Direct (or separable or traceable) Costs and Indirect (or Common or Non-traceable) Costs Shut-down and Abandonment Costs Private and Social Costs
Future

Opportunity Cost
It

is the fundamental concept in economics. The sacrifice or loss of the alternative use of a given resource is termed as opportunity cost.It is measured in terms of the forgone benefits from the next best use of a given resource. Opportunity cost is the value that is forgone in choosing one activity over the next best alternative

 Fixed

and Variable Costs Fixed costs are those costs that do not vary with the quantity of output produced.

Variable costs are those costs that do change as the firm alters the quantity of output produced. Short Run vs. Long Run Costs

 How

an Economist Views a Firm Revenue: Economic Profit=Implicit costs+Explicit Costs. How an Accountant Views a Firm Accounting profit =Explicit cost

Short-Run Cost Functions

Total

Cost = TC = f(Q) Total Fixed Cost = TFC Total Variable Cost = TVC TC = TFC + TVC

Short-Run Cost Functions

Average

Total Cost = ATC = TC/Q Average Fixed Cost = AFC = TFC/Q Average Variable Cost = AVC = TVC/Q ATC = AFC + AVC
Marginal

Cost = TC/Q = TVC/Q

Cost Concepts
and Variable Costs Short Run and Long Run Costs Total Cost, Average Cost and Marginal Cost
Fixed

AFC

Average fixed cost is the total fixed cost divided by the number of units of output produced. Therefore,

where Q represents

TFC AFC = Q

the number of units of output produced. Thus, average fixed cost is the fixed cost per unit of output. Since total fixed cost is a constant quantity, average fixed cost will steadily fall as output increases. Therefore, average fixed cost curve slopes downward throughout its length. As output increases, the total fixed cost spreads over more and more units and, therefore, average fixed cost becomes less and less. When output becomes very large, average fixed cost approaches zero.

AVC
Average

variable cost is the total variable cost divided by the number of units of output produced. Therefore,
TVC AVC = Q

Thus,

average variable cost is the variable cost per unit of output.

ATC
The average total cost or what is called simply average cost is the total cost divided by the number of units of output produced. Therefore,
TC ATC = Q
Since TC = TVC+TFC Therefore, AC = AVC + AFC

MARGINAL COST
Marginal

cost is the addition to the total cost caused by producing one more unit of output. In other words, marginal cost is the addition to the total cost of producing n units instead of n-1 units. MCn = TCnTCn-1

 Short-Run

Cost Functions
TC $60 80 90 105 140 195 AFC $60 30 20 15 12 AVC $20 15 15 20 27 ATC $80 45 35 35 39 MC $20 10 15 35 55

Q 0 1 2 3 4 5

TFC $60 60 60 60 60 60

TVC $0 20 30 45 80 135

Y Costs Figures M A M v e r a C o s a r g i C o s g e t n a l t C A A T V C C

A 0 Q
1

Q 2 Q3 u a n t i t y

F C X

Long-Run Cost Curves

Long-Run

Total Cost = LTC = f(Q) Average Cost = LAC = LTC/Q Marginal Cost = LMC = LTC/Q

Long-Run

Long-Run

 Three

Important Properties of Cost Curves Marginal cost eventually rises with the quantity of output The average-total-cost curve is U-shaped. The marginal-cost curve crosses the average total-cost curve at the minimum of average total cost.

Economies of scale

INTERNAL ECONOMIES
Arises

from the expansion of the plant size of the firm and are internalised
Internal economies are : Production economies Marketing economies Managerial economies Transport and storage economies

Production Economies
:

Tecnological advantages Specialisation and Division of labour advantages Inventory economies EXPLANATION : Tecnological advantages :Large scale production provides an opportunity to use the advantages of Tecnological advances Small scale production -The firm may not find it economical to have all the plants under one roof Ex : textile mill requires plants like spinning ,waeving ,printing and pressing ,packing . If all these plants are under one roof the firm enjoys economies of scale

Production Economies

Specialisation and Division of labour advantages: Explanation :As firm expands the scale of production workers of different skills and qualification are employed .Division of labour is possible according to their qualification and skills.This leads to Specialization which increases produtivity of labour and reduces the cost of production .Specialised workers develop efficient tools and equipments and gain speed of work. Inventory economies : Inventories in spare parts Inventories in raw materials Inventories in ready products

Marketing Economies

These economies will be enjoyed from the large scale purchase of raw materials and other material inputs & large scale selling of firms own products. From large scale purchase firm can avail discounts. Marketing the firms own products are associated with Advertising cost economies & large scale distribution through wholesalers .Advertisement expenditure also decreases . By better utilising sales force large scale distribution is possible. Exclusive dealers maintenance

Managerial economies

These economies arises from specialisation in management ,mechanisation of managerial functions.Division of

management into specialised departments is possible in large scale firms . Like production manager ,personnel manager sales manager,labour officers,etc Usage of advanced techniques of communication like computers ,fax machines,internet ,intranet leades to quick decision making process . All these leads to increase managerial efficiency and managerial cost also comes down

Transport and storage economies

These economies arises from fuller utilization of transport and storage facilities .Transport cost are incurred both on production and sales side .Storage costs are incurred on raw materials and finished products .Large size firms can have their own transport facilities which reduces their unit cost of transportation and prevents delays in transportation of goods .Large firms can have their own ware houses or godowns in various centers and can save storage costs . Ex :Oil companies have their own fleet of tankers ,some ports have their own railway tracks etc

External (or)pecuniary economies of scale

-these economies can be enjoyed by the expanding firms from the advavtages arising outside the firms.These economies are in the form of discounts and concessions like :

Lower transport cost Lower prices for bulk buying of raw materials Lower cost of finance PECUNIARY ECONOMIES Lowercost of advertising at large scale lower wages and salaries due to monopoly Lower wages and salaries due to Power of large firms Monopoly power of large firm or Or to prestige associated with large firms To prestige associated with large firms

DISECONOMIES OF SCALE

The disadvantages of large scale production that can lead to increasing average costs

Problems of management Maintaining effective communication Co-ordinating activities often across the globe! De-motivation and alienation of staff Divorce of ownership and control