In accounting, the term cost refers to the

monetary value of expenditures for

services, supplies, raw materials, labor,
products, equipment, etc. Cost is an
amount that is recorded in book-keeping
records as an expense.
 Importance of studying Costs
(i) Locating the weak points in the production
management.
(ii) Minimizing the cost.
(iii) Finding the optimum level of output.
(iv) Determining price and dealers - margins.
(v) Estimating or projecting the cost of
operation.
 COST CONCEPT & TYPES
OPPORTUNITY COST
• Opportunity cost of a factor is value of the next best
alternative forgone (that is not chosen).
• It can also defined as the revenue forgone for choosing
the best alternative use.
• The concept of opportunity cost is useful for manager in
decision making as it helps to understand the minimum
amount required to be paid to a factor to retain it in its
current use.
EXPLICIT COST
Explicit cost is the actual money expenditure on inputs or payments made to the outsiders for
hiring or purchasing the factor services. Example – wages paid to employees, payment for raw
materials etc.
 IMPLICIT COST
IMPLICIT COST is the cost of self – owned and self supplied
resources.
Example- Interest on own capital ,Rent of own land etc.
These costs are not paid to outsiders in terms of money.

ECONOMIC COST
This cost includes explicit and implicit cost both. In other words, economic cost
includes both recorded and unrecorded cost.
 ACCOUNTING COST
• Accounting cost is the cost based upon accounting records in the
book of accounts.

• They are recorded in the book of accounts when they are actually
incurred. Its based on Accrual concept.

• Accounting costs are explicit cost and must be paid.

PRIVATE COST & SOCIAL COST
• Private costs are those which are actually incurred by a firm on the purchase of
goods and services from the market. For a firm, all actual costs both explicit and
Implicit are private costs.

• Social Costs refers to the total cost borne by the society due to production of
a commodity
 Incremental and Sunk Costs

• Incremental costs are closely related to marginal costs, incremental

costs refers to the total additional cost associated with the expand in
output.

• Sunk Costs are those which cannot be altered, increased or decreased

by varying the rate of output.
 DIRECT AND INDIRECT COST
• Direct cost are the costs that have direct relationship with a unit of
operation. This includes items such as software, equipment, labor and
raw materials.

• Indirect cost are those cost whose cost can’t be easily traced to a
product such as electricity , stationary and other office expenses.
Classification of Cost in short – run

Concepts of
Cost

Total Cost Average Cost Marginal Cost

Total Average Average

Total Fixed
Variable Fixed Cost Variable
Cost
Cost Cost
 TOTAL COST
Total cost is the actual money spent to produce a particular quantity of
output.
Total cost can be further classified into:
(i) Total Fixed Cost (TFC)

(ii) Total Variable Cost (TVC)

Hence, TC is the summation of fixed and variable costs

Mathematically, TC = TFC + TVC
 TOTAL FIXED COST
TFC(Total Fixed Cost):
These costs do not vary with the change in the output i.e. whether the production is
maximum or zero, the fixed costs remain the same.
Output (units) Total Fixed Cost

0 10
1 10
2 10
3 10
4 10
5 10
6 10
7 10
8 10
 Output Total Fixed
GRAPH OF TFC (units) Cost
0 10
1 10
50
2 10
3 10
40 4 10
5 10
TFC

30 6 10
7 10

20 8 10

10 TFC

0 1 2 3 4 5 6 7 8
Output (units)
 TOTAL VARIABLE COST
TVC(Total Variable Cost):
These costs undergo a change with the change in the output i.e. if the output falls,
these costs also fall and if the output rises, these costs also rise.
Output (units) Total Variable Cost
0 0
1 10
2 18
3 24
4 28
5 32
6 38
7 46
8 62
 Output Total
TVC (units) Variable Cost
0 0
60
Inverted S – shaped graph 1 10
2 18
50
3 24
4 28
40 5 32
6 38
TVC

30 7 46
8 62

20

10

0 1 2 3 4 5 6 7 8
Output (units)
 CALCULATION OF TOTAL COST
Output (units) Total Fixed Cost Total Variable Total Cost
(TFC) Cost (TVC) TC = TFC + TVC
0 10 0
1 10 10 10
2 10 18 20
3 10 24 28
4 10 28 34
5 10 32 38
6 10 38 42
7 10 46
48
8 10 62
56
72
 TC Output
(units)
Total
Fixed
Total
Variable
Total
Cost
Cost Cost TC = TFC
70 (TFC) (TVC) + TVC

TVC 0 10 0 10

1 10 10 20
60
2 10 18 28

3 10 24 34
50
4 10 28 38

5 10 32 42
TVC, TFC, TC

40 6 10 38 48

7 10 46 56

30 8 10 62 72

20

10 TFC

0 1 2 3 4 5 6 7 8
Output (units)
 AVERAGE COST
It is the per unit cost of producing a commodity.
AC =
It can also be classified into two types:
(i) Average Fixed Cost
(ii) Average Variable Cost

Mathematically, AC = AFC + AVC

Average Fixed Cost
It is the per unit of total fixed cost of producing a commodity.
Mathematically, AFC =
Output (units) Total Fixed Cost
0 10
1 10 ---
2 10 10
3 10 5
4 10 3.33
5 10 2.5
6 10 2
7 10 1.67
8 10 1.43
1.25
 Output Average
Graph of AFC (units) Fixed Cost
0 --
10 1 10
9 2 5
3 3.33
8
4 2.5
7 AFC curve is a rectangular hyperbola 5 2

6 6 1.67
7 1.43
AFC

5
8 1.25
4

2
AFC
1

0 1 2 3 4 5 6 7 8
Output (units)
 Average Variable Cost
It is the per unit of total variable cost of producing a commodity.
Mathematically, AVC =
Output (units) Total Variable Cost
0 0
1 10 ---

2 18 10
3 24 9
4 28 8
5 32 7
6 38 6.4
7 46 6.33
8 62 6.57
7.75
 Output Average
Graph of AVC (units) Variable Cost
0 --
AVC
10 1 10
9 2 9
3 8
8
4 7
7 5 6.4

6 6 6.33
7 6.57
AVC

5
8 7.75
4
AVC is a U – Shaped curve
3

0 1 2 3 4 5 6 7 8
Output (units)
 CALCULATION OF AVERAGE COST
Output (units) Total Fixed Total Variable Total Cost OR
Cost Cost (TVC) TC = TFC + TVC
(TFC)
0 10 0
10 --- --- ---
1 10 10
20 10 10 20
2 10 18
28 5 9 14
3 10 24
34 3.33 8 11.33
4 10 28
38 2.5 7 9.5
5 10 32
42 2 6.4 8.4
6 10 38
48 1.67 6.33 8
7 10 46
56 1.43 6.57 8
8 10 62
72 1.25 7.75 9
 Output OR
Graph of AC (units)

0 --- --- ---

20
1 10 10 20

18 2 5 9 14

3 3.33 8 11.33
16 AC is a U – Shaped curve
4 2.5 7 9.5

14
AC
5 2 6.4 8.4

6 1.67 6.33 8
12
7 1.43 6.57 8
10
AC

8 1.25 7.75 9

0 1 2 3 4 5 6 7 8
Output (units)
 AC AVC
AC,AFC, AVC

AFC

Output (units)
 MARGINAL COST
It is the addition made to the total cost due to the production of one
additional unit of output.

MC =TC n − TC n −1

or

or
 CALCULATION OF MARGINAL COST
Output (units) Total Fixed Cost Total Variable Cost TC = TFC + TVC
(TFC) (TVC) OR

0 10 0 10 ---
1 10 10 20 10
2 10 18 28 8
3 10 24 34 6
4 10 28 38 4
5 10 32 42 4
6 10 38 48 6
7 10 46 56 8
8 10 62 72 16
 Output (units)
Graph of MC OR

MC 0 ---
10
1 10
9
2 8

8 3 6

7 4 4

5 4
6
6 6
TVC

5
7 8

4 8 16

2
MC is a U – Shaped curve

0 1 2 3 4 5 6 7 8
 RELATIONSHIP BETWEEN AVC, AC AND MC
MC
AC AVC

(i) When AC is falling, MC < AC.

AC,AFC, AVC

(ii) When AC is minimum, MC = AC.

(iii) When AC is rising, MC > AC.

(i) When AVC is falling, MC < AVC.

(ii) When AVC is minimum, MC = AVC.

(iii) When AVC is rising, MC > AVC.

Output (units)
RELATIONSHIP BETWEEN TC AND MC
Q. Calculate AVC and MC from the following data:
Output Total Cost

0 300

1 450

2 550

3 600

4 620
Q. Calculate AC from the following data, if AFC for the 4th unit is ₹10.
Output MC

1 40

2 30

3 35

4 39
Q. Complete the following table:
OUTPUT AVC (₹) TC (₹) MC (₹)
(units)
1 -- 60 20

2 18 -- --

3 -- -- 18

4 20 120 --

5 22 -- --
OUTPUT (units) AVC (₹) TC (₹) MC (₹)

1 --- 60 20

2 18 --- ---

3 --- --- 18

4 20 120 ---

5 22 --- ---
Q. Complete the following table:

Output (units) TC (₹) AVC (₹) MC (₹)

1 90 -- 30

2 -- 27 --

3 -- -- 27

4 180 30 --
Output TC (₹) AVC (₹) MC (₹)
(units)

1 90 -- 30

2 -- 27 --

3 -- -- 27

4 180 30 --
REASONS FOR U SHAPE OF THE AVERAGE COST CURVE
(i) Interaction between AFC and AVC: AC is the aggregate of AFC and AVC. As production rises
AFC goes on falling. In the initial stages of production, AVC also goes on falling. Consequently, the
aggregate of these two costs also falls and reaches the minimum. In this situation the firm is
making full use of its production capacity i.e. there is no idle production capacity. If the firm
produces beyond this point, the AFC will continue to fall, but AVC will begin to rise but the rate of
increase of AVC is greater than the rate of decrease of AFC. Hence AVC pulls AC with it.

(ii) Law of Variable Proportion: Before AC curve reaches its minimum, it obeys the law of
increasing return or the law of diminishing costs. At the minimum point of AC, the output is
maximum, but after this point the fixed factors will be used beyond their optimum capacity. As a
result, the production begins to diminish or the law of diminishing returns or increasing costs
sets in.
Cost - output Relationship
Cost-output relationship has 2 aspects:
Cost-output relationship in the short run,
Cost-output relationship in the long run

The SHORT RUN is a period which doesn’t permit

alterations in the fixed equipment (machinery , building
etc.) & in the size of the org.

The LONG RUN is a period in which there is sufficient

time to alter the equipment (machinery, building, land
etc.) & the size of the org. output can be increased
without any limits being placed by the fixed factors of
production
Cost-output Relationship In The
Short Run
Short Run may be studied in terms of

 Average Fixed Cost

 Average Variable Cost

 Average Total cost

Total, average & marginal cost
TC) = TFC + TVC, rise as output rises

1.Total cost (TC) = TFC + TVC, rise as

output rises
2. Average cost (AC) = TC/output
 3. Marginal cost (MC) = change in TC as
a result
 ofcost
Fixed changing output
& variable costby one unit

1.Total fixed cost (TFC) = cost of using fixed

factors = cost that does not change when
output is changed, e.g.

2.Total variable cost (TVC) = cost of using

variable factors = cost that changes when
Average Fixed Cost and Output

The greater the output, the lower the fixed cost

per unit, i.e. the average fixed cost.
Total fixed costs remain the same & do not change
with a change in output.

Average Fixed Cost and Output

The greater the output, the lower the fixed cost
per unit, i.e. the average fixed cost.

Total fixed costs remain the same & do not change

with a change in output.
Average Total cost and output

Average total cost, also known as average costs,

would decline first & then rise upwards.

Average cost consists of average fixed cost plus

average variable cost.

Average fixed cost continues to fall with an increase in

output while avg. variable cost first declines & then
rises.
So , as Avg. variable cost declines the Avg. total cost
will also decline. But after a point the Avg. variable
cost will rise.

When the rise in AVC is more than the drop in Avg.

 RELATIONSHIP BETWEEN MARGINAL AND AVERGAE
COST

• The marginal costs and average costs are

related.
• When marginal cost exceeds average cost,
average cost must be rising.
• When marginal cost is less than average cost,
average cost must be falling.
• The position of marginal cost relative to
average total cost tells us whether average
total cost is rising or falling.
Relationship between Marginal Cost and Average cost

• If MC>ATC, then ATC is rising

• If MC>MVC , then AVC is rising
• If MC< ATC, then ATC is falling
• If MC<AVC, then AVC is falling
• If MC=AVC and MC=ATC, then AVC and ATC are
at there minimum points
LONG-RUN
COSTS
 DEFINIT
ION
They are costs over a long period
of time.
They permit for enough change in all
factors of production.
Thus firms can produce more.
Supply of a commodity is adjusted to
its demand.
 LONG RUN COST
CURVES
All costs are variable in the long run.
There are only average variable cost in
long run, since all factors are variable.
It is also called as planning curve or
envelope or scale curve.
 Production Rules for
the Long Run
 If selling price > ATC (or TR > TC):
• Continue to produce.
• Maximize profit by producing where MR
= MC.
 If selling price < ATC (or TR < TC):
• There will be a continual loss.
• Sell the fixed assets to eliminate fixed
costs.
• Reinvest money is a more
profitable alternative.
 Economies
of Scale:
Economies of Scale are the cost
advantages that a firm obtain due
to expansion.
Factors responsible for this:
• Use of technically efficient machines.
• Division of labor.
• Indivisibility
• Financial economics.
 Diseconomie
s of Scale:
 Increase in long-term
average cost of production as
the scale of operations increases beyond a
certain level.
 After a certain sufficiently large size these
inefficiencies of management more than
offset the economies of scale and thereby
bring about the rise in long run average cost
& make the LAC curve upward sloping.
Determinants of Costs
 Factors determining the
cost are
(a)Size of plant: There is an inverse relationship
between size of plant and cost. As size of plant
increases, cost falls and vice versa.
(b)Level of Output: There is a direct relationship
between output level and cost. More the level of
output, more is the cost ( i. e., total cost) and vice
Versa.
(c)Price of Inputs: There is a relationship between
price of inputs and cost. As the price of inputs rises,
cost ruses and vice versa.
(d)State of technology: More modern and upgraded
the technology implies lesser cost and vice versa.

(e)Management and administrative efficiency:

Efficiency and cost are inversely related. More the
efficiency in management and administration better
will be the product and less will be the cost. Cost will
case of inefficiencies in management and
administration.
Break-Even Analysis
 What is a break-even
analysis
• Break-even analysis or what is also known as profit
contribution analysis is an important analytical
technique used to study the relationship between
the total costs (TC), Total revenue (TR) and total
profits and losses over the whole range of stipulated
output.

• The breakeven analysis is a technique of having a

preview of profit prospects and a tool of profit
planning. It integrates the cost and revenue
estimates to ascertain the profits and losses
associated with different levels of output.
To illustrate the break-even analysis under linear cost and
revenue conditions, let us assume linear cost and linear
revenue functions are given as follows.

Cost function: TC = 100 + 10 Q………..eq. (1)

Revenue function: TR = 15 Q……..……eq.
(2)

The cost function given in eq. (1) =>

firm’s TFC (total fixed cost) = 100 and its variable cost
varies at a constant rate of 10 per unit in response to
increase in output. The revenue function given in fig.
implies that price for the firm’s product is given in the
 Break-even Analysis : Linear
Function

700 TR
600 Operating
Cost and revenue profit
500 TC
400
Operating
B TVC
Loss
300
200
100 TFC
x
0 10 20 30 40
output
• The line TFC shows the total fixed cost at 100
for a certain level of output.
• The line TVC shows the variable cost rising with a
slope.
• The line TC has been obtained by plotting the TC
function.
• The line TR shows the total revenue.
• The line TR & TC lines intersect at point B
• At point B, Q = 20 ;firm’s total cost =total
revenue
• At Q=20, TC breaks-even with TR. Point B, therefore the
break-even point and Q= 20 is break-even output.
• Below this level of output, TC exceeds TR.
• Vertical difference TC-TR known as operating loss.
• Beyond Q=20, TR>TC and TR-TC is known as operating
profit.
• It may be noted that a firm producing a commodity
under cost and revenue conditions given in above eq.
(1) & (2).
• Must produce at least 20 units to make its total cost
and total revenue break-even.
• At break-even point, TR = TC
Break–even analysis under
non-linear
function
 Break–even analysis under non-linear
function
y
TC

B2
TR

Total cost and revenue

B1

F
TFC

x
0 Q1 Q2
Output per time unit
• TFC line shows the fixed cost at OF and the vertical
distance between TC and TFC measures the total
variable cost (TVC).
• The curve TR shows the total revenue at different
output & price.
• The vertical distance between the TR and TC
measure profit/loss.
• TR & TC curves intersect at two points, B1 & B2,
where TR = TC.
• OQ1 corresponding to break-even point B1 and OQ2
corresponding to break-even point B2 ;TR > TC.
• Profitable range lies between OQ1 and OQ2 units of
output.
 Thank
you
A presentation by-

1. Aishwarya
2. Arpita
3. Anvita
4. Ajay soni
5. Arpit Kumar Parashar