Costs of production (Unit III )

Ms S Chattopadhyay
PGT (Economics)
KV Ballygunge
 CBSE Syllabus …

• Costs : Short run costs – Total cost , Total

fixed costs , Total variable cost ; Average cost ,
Average fixed cost , Average variable cost &
Marginal cost – meaning & their relationships
 Introduction

• Production
• Inputs of production
• Are the inputs freely available ?
 Cost of Production

• Meaning : Expenditure incurred by the producer on

inputs used in the process of production .

• Implicit vs. Explicit Costs

Explicit costs – costs for hiring / purchasing inputs of production. Eg.
Cost of hiring labour, cost of raw materials etc
* Paid out while hiring

Implicit cost – imputed cost of self-owned or self employed inputs

based on their opportunity costs.
Eg. Rent for producer’s own land, interest for producer’s own capital
etc
* Not paid out
• Time Element in cost :

1. Long run – all factors can be changed.

2. Sort run – some factors are fixed & some
are variable.
=> some costs are fixed and some are
variable in the process of production in short
run.
• TC = TFC + TVC
 Total Fixed Cost
• Meaning :
1. Cost which does not change with the change in output
in short run. Costs of fixed factors of production.
2. Example : cost of machinery, payment of permanent
workers etc.
3. Commonly referred to as "overhead cost."
• Nature of TFC :
1. Remains constant.
2. TFC ≠ 0 even if Q = 0
3. TFC curve is a horizontal straight line.
• TFC Q
 Total Variable Cost
• Meaning :
1. Cost which changes with change in output.
2. Example : cost of raw material, payment to casual
workers etc .

• Nature of TVC :
1. Changes directly with change in output.
2. TVC = 0 when Q = 0
• TVC curve is an upward sloping curve starting from
origin.
 Total Cost

• TC = TFC + TVC Unit of TFC TVC TC

output
• Numerical example. 0 12 0 12

1 12 6 18

2 12 10 22

3 12 15 27

• At Q = 0 , TVC = 0 and TC = TFC.

• TC curve is an upward sloping curve starting from a
height(=TFC).
 Relation : TC &TVC

Output TVC TC
TFC
(units)

0 12 0 12
1 12 6 18
2 12 10 22
3 12 15 27
4 12 24 36
 Relation : TC &TVC

• TC = TFC + TVC
TC – TVC = TFC
• TFC is not equal to zero & it remains constant.
Hence TC & TVC curves are parallel to each
other.
• Since TFC remain constant for all levels of
output , nature of TC depends exclusively on
the nature of TVC only
 Application
• Complete the table :
• Q TC TFC TVC (= TC – TFC)
• 0 15 15 0
• 1 17 15 2
• 2 20 15 5
• 3 25 15 10
Note : At Q=0, TC = TFC
TFC remains constant
 Average Variable Cost

• Meaning: AVC is TVC per unit of output

produced
Mathematically:
AVC = TVC / Q
• AVC initially falls , reaches a minimum and
there after increases
• Hence AVC curve is ‘U’ shaped in nature
 AVC Schedule & Curve
AVC Schedule AVC Curve
AVC = TVC/Q
Output (units) TVC

0 0 -

1 6 6

2 10 5

3 15 5

4 24 6

5 35 7

6 48 8
 Average Fixed Cost

• Meaning: AFC is TFC per unit of output

produced
• Mathematically:
AFC = TFC / Q
• AFC falls with increase in output as TFC
remains constant
• AFC can never be negative as TFC and Output
are always positive
 AFC Schedule & Curve
AFC curve is Rectangular hyperbola
AFC Schedule AFC Curve
Output AFC =
TFC
(units) TFC/Q
0 12 ∞
1 12 12
2 12 6
3 12 4
4 12 3
5 12 2.4
6 12 2
 Average Total Cost (ATC) or Average Cost (AC)

• It refers to the Total Cost per unit of output

produced.
• AC = TC / Q
• With increase in output AC..….. AC curve is U
shaped.
• TC = TFC + TVC
=> TC/Q = TFC/Q + TVC/Q
Þ AC = AFC + AVC
Þ AC curve will be U shaped due to LVP
 AC : AVC : AFC
AC – AVC = AFC & AFC falls with increase in output , hence the
difference between the two reduces . But AC will never be
equal to AVC as AFC is never equal to zero.

Q TFC TVC AFC = TFC/Q AVC = AC = AFC +

TVC/Q AVC

0 12 0 00 0 00

1 12 6 12 6 18

2 12 10 6 5 11

3 12 15 4 5 9

4 12 24 3 6 9
5 12 35 2.4 7 9.4

6 12 48 2 8 10
 Relation : AC & AVC
With increase in output, both AFC & AVC fall and hence AC
falls. After certain level first AVC reaches its minimum (Point
B) & rises and then AC reaches its minimum (A) & then rises.
The difference between AC & AVC is AFC and AFC falls with
increase in output . Hence the two curves comes closer but
never intersect each other as AFC is never equal to zero
• AFC = TFC / Q
• TFC is never equal to zero, hence AFC will also
be not equal to zero
 Points to Remember
• TC = TFC + TVC
TVC = TC - TFC
• At Q= 0 , TVC = 0 & TC = TFC
• TFC remains constant
• AC = TC/Q OR AC = AFC + AVC
• AVC = TVC/Q
• AFC = TFC/ Q
 Application: Complete the table
• Q TC TFC TVC AC AFC AVC
• 0 10 10 0 00
• 1 12 10 2 12
• 2 15 10 5 7.5
• 3 19 10 9 6.3
• Note : AC = TC/Q, At Q=0 , TFC=TC , TFC
remains constant , TVC = TC – TFC ,
• AFC= TFC/Q , AVC = TVC/Q
 Marginal Cost

• Marginal is the rate of change in total. Cost changes

due to change in output.
• Marginal cost is change in total cost resulting from
the change in production of output by one unit.
• MC = ∆TC / ∆Q OR MC = ∆TVC / ∆Q
• Numerical example.
 Complete the table :
• Q TC TFC TVC = TC - TFC MC = Ch in TVC/ Ch in Q
• 0 45 45 0 -
• 1 75 45 30 30/1 = 30
• 2 100 45 55 25/1 = 25
• 3 120 45 75 20/1 = 20
 MC depends on TVC only
• MC = Ch in TC / Ch in Q
• = (Ch in TFC + Ch in TVC) / Ch in Q
• = (0 + Ch in TVC) / Ch in Q { as Ch in TFC = 0}
• = Ch in TVC / Ch in Q

MC = ∆TC / ∆Q OR MC = ∆TVC / ∆Q
 MU – MP - MC
• Marginal cost is change in total cost resulting from the
change in production of output by one unit.
• MC = ∆TC / ∆Q
• Marginal product is change in total product resulting
from the change in use of variable factor by one unit.
• MP = ∆TP / ∆L
• Marginal Utility is change in total utility resulting from
the change in consumption by one unit.
• MU = ∆TU / ∆C
• MARGINAL IS THE RATE OF CHANGE IN TOTAL
 Other ways of calculating MC

• MCn = TCn - TCn-1

Explanation with numerical example.
• Process Of calculating TC from MC :
TC = ∑ MC
Explanation with numerical example.
* Proof : MC depends on TVC.
 Example
• U TC
• 1 20
• 2 3 30
• MCn = TCn – TCn-1
• MC2 = TC2 - TC 2 – 1 (applicable when consecutive units of production is given)
• = 30 – 20 = 10

• MC = Ch in TC / Ch in Q
• = 10/1 = 10
 AC - MC Relation schedule
• Q TC AC = TC/Q MC = Ch in TC/Ch in Q Remarks
• 1 20 20 -- when MC < AC, AC falls
• 2 28 14 8
• 3 34 11.3 6
• 4 38 9.5 4
• 5 42 8.4 4 MC minimum
• 6 48 8 6
………………………………………………………………………………………………………….
• 7 56 8 8 MC = AC & AC mimimum
& Constant
• …………………………………………………………………………………………………....
• 8 66 8.25 10 MC > AC , AC rises
• 9 90 10 24
MC The Marginal Cost curve passes
through the minimum point of
AC
the AC curve.
MC (Marginal Cost)
It is also U-shaped. First it
decreases, reaches a minimum AC
and then increases. MC > AC
(Average Cost)

MC < AC, AC falls

MC = AC, AC Minimum

Minimum AC
MC min

0 q1 Q
AC – MC Relation
 Relation : AC & MC

• AC = TC / Q , MC = TC / Q

• When MC < AC , MC pulls AC down & AC falls (below

q 1)

• When MC = AC , AC reaches its minimum (at q 1)

• When MC > AC , AC rises (above q1)

 Can AC fall when MC rises ??
• YES
• AC falls as long as MC < AC
 Relation : AC, AVC & MC
• AC = TC / Q , MC = TC / Q , AVC = TVC/Q

• When MC < AC , MC pulls AC down & AC falls (below q 1)

When MC < AVC , AVC falls

• When MC = AC , AC reaches its minimum (at q 1)

When MC = AVC, AVC reaches its minimum

• When MC > AC , AC rises (above q1)

When MC > AVC, AVC rises
* Minimum of MC comes first , then Min of AVC & Finally min of AC with
increase in output.
MC MC < AC, AC falls MC

AC MC > AC, rises

AVC AC

AVC
MC < AVC, AVC falls

MC = AVC, AVC Minimun

MC min
AFC

0 q1 Q

AC – AVC – MC : Relation
 7 Cost Concepts (Short-run)

1. Total Fixed Cost (TFC)

2. Total Variable Cost (TVC)
3. Total Cost (TC = TVC + TFC)
4. Average Fixed Cost (AFC = TFC / Q)
5. Average Variable Cost (AVC = TVC / Q)
6. Average Total Cost (AC = AFC + AVC)
7. Marginal Cost (MC = ∆ TVC / ∆Q)
8. Marginal Cost (MC = ∆ TC / ∆Q)
Thank you