WHAT IS COST?

COST DETERMINANTS: q OUTPUT LEVELS q PRICES OF FACTORS OF PRODUCTION q PRODUCTIVITIES OF FACTORS OF PRODUCTION q TECHNOLOGY

COST FUNCTION
COST FUNCTION GIVES THE RELATIONSHIP BETWEEN COST & THE VARIOUS COST DETERMINANTS.
A COMPREHENSIVE COST FUNCTION AS GIVEN BY MOTE, PAUL & GUPTA, CAN BE STATED AS FOLLOWS:

TCx=f (x, PF, EF, T)

COST & COST FUNCTION

WHERE, TCx = TOTAL PRODUCTION COST OF COMMODITY X X = OUTPUT OF COMMODITY X PF = VECTOR OF PRICES OF ALL FACTOR INPUTS USED IN THE COMMODITY Xs PRODUCTION

COST & COST FUNCTION

E F = VECTOR OF EFFICIENCIES OR PRODUCTIVITIES OF ALL FACTOR INPUTS USED IN THE PRODUCTION OF COMMODITY X T= EXTENT OF TECHNICAL PROGRESS IN THE PRODUCTION OF COMMODITY X f= UNSPECIFIED FUNCTION f1= PARTIAL DERIVATIVE OF f WITH RESPECT TO THE ith VARIABLE

COST FROM ACCOUNTING PERSPECTIVE

ELEMENTS (DIRECT / INDIRECT) FUNCTIONS OR OPERATIONS (SELLING / PRODUCTION / ADMIN / RESEARCH / DISTRIBUTION / DEV./ PRE-PROD. etc.) NATURE OR BEHAVIOUR (FIXED / VARIABLE / SEMI-VARIABLE) CONTROLLABILITY (CONTROLLABLE / UNCONTROLLABLE) NORMALITY (NORMAL / ABNORMAL)

COST & COST FUNCTION

FROM THE MANAGERIAL ECONOMIC PERSPECTIVE, HOWEVER, WE COULD CATEGORISE THE COSTS INTO: q TOTAL COSTS q FIXED COST / AVERAGE COST / MARGINAL COST q SHORT / LONG RUN COST

COST & COST FUNCTION

TOTAL COSTS ARE GENERALLY DIVIDED INTO TWO COMPONENTS:

FIXED COSTS & VARIABLE COSTS

AL COSTS (TC), THEREFORE, ARE THE SUM OF FIXED COSTS (FC) & VARIABLE COSTS (VC) :

TC =FC + VC
FIXED COSTS ARE THE COSTS THAT DO NOT CHANGE AS OUTPUT CHANGES. THEY ARE INCURRED EVEN IF NO OUTPUT IS PRODUCED AT ALL.

COST & COST FUNCTION

FIXED COSTS ARE THE COSTS THAT DO
NOT CHANGE AS OUTPUT CHANGES. THEY ARE INCURRED EVEN IF NO OUTPUT IS PRODUCED AT ALL VARIABLE COSTS ARE THOSE COSTS WHICH DO CHANGE AS THE FIRM CHANGES THE OUTPUT. VARIABLE COSTS WOULD INCREASE IF THE OUTPUT IS INCREASED & WOULD DECLINE IF THE OUTPUT IS DECREASED

MARGINAL COST
qMARGINAL COST IS A KEY ELEMENT IN
DECISION MAKING WHENEVER THE FIRM FACES A DECISION-MAKING SITUATION LIKE SHOULD WE EXPAND OUR PRODUCTION? qMARGINAL COST IS THE INCREASE IN TOTAL COST WHEN ONE ADDITIONAL UNIT IS PRODUCED.

AVERAGE COST
AVERAGE TOTAL COST OR AVERAGE COST CAN BE EXPRESSED / REPRESENTATED AS FOLLOWS: TOTAL COST AC = -----------------------------THE NUMBER OF UNITS AVERAGE TOTAL COST OR AVERAGE COST, THERFORE, IS THE SUM-TOTAL OF AVERAGE FIXED COST & AVERAGE VARIABLE COST:

ATC = AFC + AVC

SHORT RUN COSTS

SHORT RUN IS THE PERIOD WHEN ONE OR MORE INPUTS ARE FIXED SHORT RUN IS NOT DEFINED AS ANY SPECIFIC NUMBER OF WEEKS, MONTHS, OR YEARS. INSTEAD, IT IS THE PERIOD WHEN PLANT, EQUIPMENT OR SOME OTHER INPUT IS FIXED, WHATEVER THE PERIOD MIGHT BE

LONG RUN COSTS

LONG RUN IS THE PERIOD WHEN THE FIRM IS ABLE TO CHANGE THE QUANTITIES OF ALL INPUTS, INCLUDING CAPITAL & LAND

RELATIONSHIP
WHENEVER THE MARGINAL COST IS BELOW THE AVERAGE TOTAL COST CURVE, THE ATC IS FALLING. THIS MUST BE SO AS THE LOW MARGINAL COST DRAGS DOWN THE AVERAGE WHEN THE MARGINAL COST IS ABOVE THE AVERAGE COST, IT PULLS THE AVERAGE UP, THE AVERAGE CURVE RISES

RELATIONSHIP
FINALLY, WHEN THE MARGINAL COST EQUALS THE AVERAGE COST, THEN THE MARGINAL COST HAS A NEUTRAL EFFECT IT NEITHER PULLS THE AVERAGE UP NOR DRAGS IT DOWN AVERAGE COST IS FLAT, IT HAS REACHED ITS LOWEST POINT

AVERAGE & MARGINAL COSTS:

RELATIONSHIP

THUS THE MARGINAL COST CURVE CUTS THROUGH THE LOWEST POINT ON THE AVERAGE TOTAL COST CURVE. THE SAME IS TRUE OF AVERAGE VARIABLE COST: MARGINAL COST CUTS THROUGH ITS LOWEST POINT, TOO.