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Cost Analysis

Cost analysis involves understanding different types of costs incurred by a firm in production. There are fixed costs that remain constant, variable costs that change with output, and total costs which are the sum of fixed and variable. Marginal cost is the change in total cost from producing one additional unit of output and is an important consideration in production decisions. Opportunity cost is the value of the next best alternative forgone in making a decision. Costs are classified as explicit, which are actual monetary payments, and implicit, which represent forgone opportunities.

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86 views20 pages

Cost Analysis

Cost analysis involves understanding different types of costs incurred by a firm in production. There are fixed costs that remain constant, variable costs that change with output, and total costs which are the sum of fixed and variable. Marginal cost is the change in total cost from producing one additional unit of output and is an important consideration in production decisions. Opportunity cost is the value of the next best alternative forgone in making a decision. Costs are classified as explicit, which are actual monetary payments, and implicit, which represent forgone opportunities.

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jia
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© © All Rights Reserved
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COST ANALYSIS

WHAT DO MEAN BY COST?


Production and cost are two sides of a same coin. There
can not be any production without incurring cost and at the
same time cost without production has no economic
significance.

Therefore to do some Production a firm has to do some


expenditures..
CONCEPT:
 In Economics, cost of production has a special meaning.
 It is all of the payments or expenditures necessary to obtain the factors of
production-land, labor, capital and management required to produce a commodity.
The following elements are included in the cost of production:
a. Purchase of raw material
b. Installation of machinery ad plant
c. Wages of labor
d. Rent of the building
e. Interest on capital
f. Wear and tear of machinery and building
g. Advertisement expenses
h. Insurance charges
i. Payment of taxes
j. The normal profit of the entrepreneur is also included in the cost of production.
By normal profit, it is meant the sum of money which is necessary to keep an
entrepreneur employed in a business.
DIFFERENT CONCEPTS OF COST:
EXPLICIT COST:
Also known as accounting cost.
 It represents all such expenditure which are
incurred by an entrepreneur to pay for the hired
services of FOP and in buying goods and
services directly.
 Expenses which must take into account of
because they must actually be paid by the firm.
IMPLICIT COSTS:
It is also called imputed cost
 It can be defined as expenses that an entrepreneur does not
have to pay out of his own pocket but are costs to the firm
because they represents an opportunity cost.

 A business doesn't record implicit costs or transactions for


accounting purposes because no money is changing hands. 
OPPORTUNITY COST:

A benefit, profit, or value of something that


must be given up to acquire or achieve
something else.
SHORT VERSUS LONG RUN

 The short run is a period of time sufficiently short that


only some of the variables can be changed.

 The long run is a period of time that all variables can be


changed
SHORT RUN COSTS TO THE FIRM
Cost of a firm (TC) is classified into two broad categories –
Total Fixed cost (TFC) and Total Variable cost (TVC).
 Fixed cost

 Variable cost

i.e.

TC = TFC + TVC
FIXED AND VARIABLE COSTS:
 Fixed costs are costs that are independent of output.
 These remain constant throughout the relevant range .

 Fixed costs often include rent, buildings, machinery, etc.

 Variable costs are costs that vary with output.

 Generally variable costs increase at a constant rate


relative to labor and capital.
 Variable costs may include wages, utilities, materials
used in production, etc.
TOTAL FIXED COST

Fixed cost remains unchanged with the level of output.

TFC= TC-TVC
TOTAL FIXED COST

100

80

60

40

20

0
0 1 2 3 4 5 6 7 8
VARIABLE COSTS

Variable cost
 It means that cost which is changing with the change in
output.

TVC = TC -TFC
TVC

100

80

60

40

20

0
0 1 2 3 4 5 6 7 8
FIXED COSTS, VARIABLE COSTS, AND TOTAL COSTS

 The sum of the variable and fixed costs are total costs.

TC = FC + VC
TOTAL COST

100

80

60

40

20

0
0 1 2 3 4 5 6 7 8
AVERAGE COSTS

 Average fixed cost equals fixed cost divided by quantity


produced.

AFC = TFC/Q
AVERAGE COSTS
 Average variable cost equals variable cost divided by
quantity produced.

AVC = TVC/Q
AVERAGE TOTAL COSTS
 Average total cost (ATC): the per unit cost derived by
dividing total cost by the quantity of output.
AC = AFC + AVC or

total cost
ATC 
total output
MARGINAL COST

 Marginal cost is the increase (decrease) in total cost of


increasing (or decreasing) the level of output by one unit.

 In deciding how many units to produce, the most


important variable is marginal cost.

 MC = TC /  Q
Output TFC TVC TC AFC AVC ATC MC

0 24 0 24 - - - -

1 24 28 52 24 28 52 28

2 24 54 78 12 27 39 26

3 24 75 99 8 25 33 21

4 24 96 120 6 24 30 21

5 24 126 150 4.8 25.2 30 30

6 24 168 192 4 28 32 42

7 24 214 238 3.4 30.6 34 46

8 24 264 288 3 33 36 50

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