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Lecture-10 Cost of Production (1) ..

Here are the calculations based on the information provided: Output (Q) Total Cost (TC) 0 $100,000 100 $150,000 200 $210,000 300 $270,000 Fixed Cost (FC) = Total Cost when Q=0 = $100,000 To calculate other values, we need the Total Variable Cost (TVC) at each level of output. TVC = TC - FC So, TVC at Q=100 is $150,000 - $100,000 = $50,000 TVC at Q=200 is $210,000 - $100,000 = $110,

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39 views

Lecture-10 Cost of Production (1) ..

Here are the calculations based on the information provided: Output (Q) Total Cost (TC) 0 $100,000 100 $150,000 200 $210,000 300 $270,000 Fixed Cost (FC) = Total Cost when Q=0 = $100,000 To calculate other values, we need the Total Variable Cost (TVC) at each level of output. TVC = TC - FC So, TVC at Q=100 is $150,000 - $100,000 = $50,000 TVC at Q=200 is $210,000 - $100,000 = $110,

Uploaded by

Movie Series
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© © All Rights Reserved
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Lecture 10

The Cost of Production


Sumaiya Nabi Khan
Cost of Production
Cost is the value of inputs used to produce its output; for example the firm hires labor,
and the cost is the wage rate that must be paid for the labor services.

Total Cost
Total Cost (TC) represents the lowest total dollar expense needed to produce each level
of output q.
TC rises as the level of output rises.

Total Cost can be divided into two components:

Fixed Cost (FC)


Variable Cost (VC)
Fixed Cost (FC)
Fixed cost represents the total dollar expense that is paid out even when no output is
produced.

Fixed cost is unaffected by any variation in the quantity of output.

Sometimes they are called “overhead” or “sunk cost”. They are fixed because they do not
change if output change.

Example: rent for factory or office space. Interest payment for debt, salaries.
Variable Cost (VC)
Variable cost represents expenses that vary with the level of output – such as raw
materials, wages, and fuel – and includes all costs that are not fixed .

Example: materials required to produce output (Steel to produce automobile), Power to


operate factories and so on.

By definition, VC begins at zero when q is zero. VC is a part of TC that grows with


output; indeed, the jump in TC between any two outputs is the same as the jump in VC.
Total Cost Contd.
Now, always by definition:

TC = FC +VC

The curve for total fixed cost is a


horizontal line and Total variable
cost curve is upward slopping.
Total Cost Contd.
Now, always by definition:

TC = FC +VC

The curve for total fixed cost is a


horizontal line and Total variable
cost curve is upward slopping.
Marginal Cost
Marginal cost (MC) denotes the extra or additional cost of producing 1 extra unit of
output.

The marginal cost curve is usually U-shaped. Marginal cost is relatively high at small
quantities of output; then as production increases, marginal cost declines, reaches a
minimum value, then rises.

In the short run capital is fixed but labor is variable. In such a situation, there are
diminishing returns to labor because each additional unit of labor has less capital to work
with. As a result, the marginal cost of output will rise because the extra output produced by
each extra labor unit is going down. In other words, diminishing returns to the variable fac-
tor will imply an increasing short-run marginal cost. This shows why diminishing returns
lead to rising marginal costs.
Marginal Cost Contd.
For most production processes the
marginal product of labor initially rises,
reaches a maximum value and then
continuously falls as production increases.

Thus marginal cost initially falls, reaches


a minimum value and then increases.
Average Cost
Average Total Cost (ATC) is the total cost (TC) divided by the level of output (Q).

Average total cost tells us the per-unit cost of production.

Average Fixed Cost (AFC) is the total fixed cost (TFC) divided by the level of output (Q)

Average Variable Cost (AVC) is the total variable cost (TVC) divided by the level of out-
put (Q).
Average Cost Contd.
AC is a U-shaped curve.

Average cost is a combination of average fixed cost and average variable cost. As a firms
sells more output, it can spread it’s fixed cost over more and more units.

Therefore, as the level of output increases, the average costs fall more sharply.  

If the firm tries to raise output after a point by increasing the quantities of variable
factors, for diminishing returns to scale the average cost rises.
Average Cost Contd.
When marginal cost is below
average cost, it is pulling average
cost down.

When MC is above AC, it is


pulling up AC.

When MC just equals AC, AC is


constant.

At the bottom of a U-shaped AC,


MC =AC = minimum AC
Problem
The accompanying table shows a
car manufacturer’s total cost of pro-
ducing cars.

What is the Fixed Cost (FC) for this


production.

 For each level of output calculate


the Variable Cost (VC) average vari-
able cost (AVC) and average fixed
cost (AFC), Average total Cost (ATC)
and Marginal Cost (MC.

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