Concept of Cost Class 11 | Chapter 8 | Economics | CBSE |

Concept of Cost Class 11 | Chapter 8 | Economics

Cost

Cost refers to the expenditure incurred by a producer on factor input as well as on new factor input for a given output of a commodity.

Total Cost= Explicit Cost + Implicit Cost

Cost is always measured as opportunity cost because cost of producing a given amount of output is to be measured in terms of the sacrifices made in the producing that output.

Explicit Cost

It is the opportunity cost of hiring purchasing input from market in short it is the payment made by a firm to other for hiring purchasing input from the market. For example, wages paid to the workers payment of electricity bill. Explicit cost is also known as actual cost or outlay cost or absolute cost.

Implicit Cost

It is the opportunity cost of using self-owned inputs. It is the market value of self-owned inputs in their next best alternative use. For example, estimated rent of entrepreneurs on building estimated interest on entrepreneur’s own capital salary for services of entrepreneur etc.

Selling Cost 

It refers to expenditure incurred by the producer to promote sale of the commodity. For example, expenses on advertisement.

Production Cost 

It refers to the expenditure incurred by a producer on the inputs for producing a given level of output.

Short Run Cost 

Short run is a period of time during which some factors are fixed and some are variable. It has two components: fixed cost and variable cost.

TC=TVC+TFC

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Fixed Cost or Total Fixed Cost

It is the sum total of expenditure incurred by the producer on hiring/purchasing fixed factors of production. It is also known as indirect supplementary or overhead cost. TFV remains constant during short run. It does not change with increase or decrease in output.

For Example: Expenditure on plane & machines, salaries of permanent staff etc, rent of factory.

Total variable cost (TVC) 

It refers to the expenditure incurred by the producer on the variable factors of production. It changes with the change in the level of output. It is also known as prime cost or direct cost. As output increases, TVC increases & as the output decreases TVC decreases and when the output is zero, TVC is also zero.

For Example: Cost of raw material, electricity expenses etc.

Behaviour of Fixed Cost, Variable Cost and Total Cost 

      Or

Relationship Between TFC, TVC And TC 

• TC = TVC +TFC
• TC and TVC curves have the similar shapes, the only difference between them is that TVC starts from origin whereas TC starts above the origin
• At zero level of output, there is no variable cost, it means TC =TFC, initially TVC increases at decreasing date because addition cost of producing every successive unit tends to fall.
• Afterwards TVC increases at the increasing rate because MP of variable factor tends to fall so more & more of additional cost is increased for producing every additional unit of output.
• TC is parallel to TVC because the variable distance between them is TFC (TC -TVC) which is constant.
• TF is constant at all the level of output
• TVC increases with increase in output & vice versa.

Average Cost/Average Total Cost 

Average cost is the cost per unit of output product. It is also called unit cost of production.

Average fixed cost is the fixed cost of per unit of output.

Average variable cost  is the variable cost of per unit of output.

AFC curve is rectangular hyperbola. It we take any point on AFC curve and multiply AFC at that point corresponding level of output, the product (AFC×Q=TFC) shall always be the same.

AVC curve is U – shaped accordance with the law of variable proportions. It falls so long as returns to factors are increasing. AVC rises when returns to a factor starts decreasing.

Relationship between AC, AFC, AVC

• AC curve is vertical summation of AFC &AVC curves
• AC never touches AVC because the vertical distance between AC & AVC is AFC which us always positive.
• The level of output at which AC is minimum is known as optimum level of output.
• Minimum points on AC curve lies to the right of the minimum point on AVC curve.
• As output increases, AFC continuously fall because TFC is constant.

Marginal Cost 

Marginal cost is the addition to total cost when an additional unit of output is produced.

MC=TC_n-TC_(n-1) or MC=∆TC/∆Q

Marginal cost is not affected by fixed cost – MC is independent of FC because FC does not change with output. It is the only variable cost with change with the change in the level of the output in the short run. MC is an additional cost corresponding to an additional unit of output. So additional cost cannot be fixed cost, it can only be variable cost.

∑MC=TVC       or       MC_n=TVC_n-TVC_(n-1)

Relationship between AC and MC

• When AC falls MC falls faster than AC. MC falls more rapidly than AC (MC<AC).
• When AC rises, MC rises faster than AC. (MC>AC).
• When AC intersects MC (AC=MC), here AC constant
• As MC declines and rise more rapidly than AC. So, MC intersects AC from below.
• When MC cut AC, here AC is at lowest point.

Relationship between TC/TVC and MC

• When TVC/TC increases at diminishing rate, MC declines.
• When TVC/TC increases at increasing rate, MC rises.
• When TC/TVC stops increasing at diminishing rates, MC at its lowest point.
• ∑MC =TVC.

Relationship between AC, AVC, AFC AND MC

• AC and AVC get close as output increases because AC tend to increase.
• AC and AFC get away from each other as output increases because AFC tends to decline but never be zero as TFC Is constant.

MC is reciprocal of MP- It implies that falling MC corresponds to rising MP and rising MC corresponds to falling MP.

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