■ Cost function → The cost function of a firm shows the relationship between output produced and the associated

cost of producing it. It

also means The cost function describes how the firm's total costs depends or vary with its output.

The cost function is written as – C= C(Q)

■ Types of Cost functions – There are 3 types of cost functions – A. Linear cost function B. Quadratic cost function C. Cubic cost function

Linear cost function estimation -- If there is constant returns to variable factor the cost function is of linear type. A linear cost function may
be expressed as –

TC = a + b . Q

1. When Q = 0 , TC is equal to a . This means the term a in the equation denotes total fixed cost of production i.e TFC
2. The term b.Q in the equation denotes total variable cost of production i.e TVC

■ TFC under linear cost equation -- when output is zero the total cost is equal to total fixed cost which is denoted by the constant term a.

Therefore the total fixed cost remains constant with change in quantity of output. Hence total fixed cost curve will be a completely
horizontal curve as shown in following diagram –

■ TVC under linear cost equation -- The term b.Q represents total variable cost i.e TVC . Therefore with every increase in Q , TVC ( b.Q ) will
increase continuously. Since b is a constant term therefore TVC will increase at a constant rate ( = b ) with every increase in output. Another
words they are would be constant returns to the variable factor. Hence the TVC curve will be a straight line upward sloping curve passing
through origin.

■ TC under linear cost equation – As total fixed cost remains constant at all levels of output, with every increase in quantity of output, the
total cost will change exactly by the amount of change in total variable cost. Since TC = TFC + TVC = a + b. Q , therefore the TC curve will be a
straight line upwards looking curve but instead of passing through origin it will start from the TFC curve as shown in following figure --

■ AFC under linear cost equation -- As TFC is constant therefore any increase in quantity of output leads to continuous decrease in AFC.

In other words – AFC = TFC / Q = b / Q . So every increase in Q means b / Q will decrease. AFC curve will be a rectangular hyperbola
■ AVC under linear cost equation – Since TVC = b . Q , therefore AVC = b.Q / Q = b. Hence AVC is constant here. As a result the AVC curve is a
horizontal curve parallel to the output axis

■ AC under linear cost equation -- AC is derived dividing the TC by quantity of output Q , therefore we can write –

AC = TC / Q = ( a + b. Q ) / Q = ( a / Q ) + b

When output Q increases , the term ( a / Q ) decreases and as b is a constant term , therefore AC will continuously fall with increase in
output but will never be zero because of the term b. Hence shape of AC curve under linear cost equation is a rectangular hyperbola .

■ MC under linear cost equation -- MC is change in TC due to change in quantity of output , hence we can write –

MC = d (TC)/ dQ = d ( a + b. Q ) / dQ = b
As MC is equal to the constant term b therefore MC remains unchanged with any increasing output. Hence MC curve is a horizontal line
parallel to the output axis

Quadratic Cost Function Estimation

When there is diminishing return to the variable Factor The cost function becomes quadratic . Quadratic cost function is expressed as –

TC = a + b . Q + c . Q 2 where , a > 0 , b > 0 and c > 0

From above equation it is clear that TC = a , when Q = 0. The term a is the fixed cost. The ( b.Q + c. Q 2 ) is the TVC
■ TFC ➔ From the quadratic cost function it is clear that , TFC = a = constant. Therefore TFC remains unchanged when output increases and
hence TFC curve is a horizontal curve parallel to the output axis.

■ TVC ➔ Since TVC = b . Q + c . Q 2 , therefore TVC increases at an increasing rate with every increasing output level. When Q = 0 , TVC = 0.

Hence TVC curve is an upward rising convex curve towards output axis but starting from the origin

■ TC ➔ When cost function is quadratic in nature , the TC increases with increase in output but at an increasing rate because change in TC is
similar to the change in TVC. Hence TC curve is an upward rising convex curve starting from the point of TFC.

■ AFC ➔ As TFC is constant therefore any increase in quantity of output leads to continuous decrease in AFC.

In other words – AFC = TFC / Q = a / Q . So every increase in Q means a / Q will decrease. AFC curve will be a rectangular hyperbola

■ AVC ➔ the AVC for quadratic cost function is calculated as – AVC = TVC / Q = ( b . Q + c . Q 2 ) / Q = b + c . Q
Therefore with every increasing output level the AVC will increase. And the shape of the AVC curve will be as follows --
■ MC ➔ Since MC is the change in TC due to change in quantity hence we can write –

MC = d (TC)/ dQ = d ( a + b. Q + c . Q 2 ) / dQ = b + 2 c Q

Hence MC is an increasing function of output and as a result the MC curve is as follows --

Cubic cost function estimation

The Cubic cost function is based on 2 assumptions –

1. Total cost is equal to fixed cost when Q = 0

2. With an increase in output, increasing return to variable factor is found in initial stage ; afterwards constant returns to variable
factor is reached and finally there is diminishing return to variable factor

The Cubic cost function is written as – TC = a + b . Q + c . Q 2 + d . Q 3 where , a , b , d > 0 ; c < 0 but c 2 > 3bd

■ TFC ➔ From the quadratic cost function it is clear that , TFC = a = constant. Therefore TFC remains unchanged when output increases and
hence TFC curve is a horizontal curve parallel to the output axis.

■ TVC ➔ As TVC = b . Q + c . Q 2 + d . Q 3 , therefore TVC initially increases at decreasing rate and then from the inflection point it increases at
increasing rate. Hance TVC is an inverted S shaped curve passing through origin.

■ TC ➔ Since change in TC is always captured by the change in TVC therefore the TC also increases at decreasing rate in initial stage and
from the point of inflection it increases at increasing rate. Therefore TC curve is an inverted S shaped curve starting from the TFC curve
■ AFC ➔ SAME

■ AVC ➔ the AVC is written as = AVC = TVC / Q = ( a + b.Q + c.Q 2+ d.Q 3 ) / Q = a / Q + b + c.Q + d.Q 2

Hence AVC initially decreases and then it increases , as a result AVC becomes a U shaped curve

■ MC ➔ MC is written as = MC = d (TC)/ dQ = d ( a + b. Q + c . Q 2 + d . Q 3 ) / dQ = b + 2 c Q + 3dQ 2

Hence with every increase in quantity of output the MC initially decreases and then it starts increasing corresponding to the inflection point
of TVC curve. The MC curve intersects AVC curve at its minimum point. Thus it is a U shaped curve.