Meaning of Cost
Cost refers to all those expenses that are included to produce a product. Cost of production is an integral part of price theory; it plays an important role in the output determination of a company.
Practical importance of cost analysis helps a manager to calculate total amount required to produce the product to calculate number of raw material required labor and wages rate and it helps to fix the price for finished product.
Cost Output Analysis
There are various types of cost separated on the basis of their nature like:-
- Fixed cost (FC)
- Variable cost (VC)
- Total cost (TC)
- Average cost (AC)
- Marginal cost (MC)
- Average fixed cost (AFC)
- Average variable cost (AVC)
Cost Output Relationship on the Basis of Time Period
Short run cost output relationship
It refers to various costs required to produce the product within 1 year of one production cycle. The following costs are included 1. FC to VC to STC (shot total cost), SAC bracket (short run average cost).
Long run cost output relationship
Long run refers to the time period that is from year to year to 1 year to unlimited year.
Following cost can be include
- FC to VC ( fixed cost to variable cost )
- LTC ( long run total cost )
- LAC ( long run average cost)
- LMC (long run marginal cost)
Concept of Cost Analysis
Assume that F= Fan
Q=F (land, labor, capital, organization, spare parts, elastic, printer, transportation, advertisement overhead expenses, etc)
Types of Cost Concepts
1. Accounting cost
2. Economic cost
Accounting cost concept
It is considered all these expenses that are in the book of accounts.
- Money cost
- Real cost
- Explicit cost
- Implicit cost
Following cost are include during production function
- Payment made for raw material
- Expenses on electricity and petrol
- Wages and rent payment
- Market expenses
- Insurance expenses
- Transportation expenses
- Packaging expenses
- Normal profit
- Money cost producing and output of a commodity is the sum of all expenses given above
- Real cost it refers to individual exertion of all factor of production that is called real cost
- Explicit cost all the cost payment during production is called explicit cost. Ex- wages, rent, salary interest profit and cost of raw material and overhead expenses.
- Implicit cost of self supplied resources are known as implicit cost for example using personal vehicles for company or personal resources.
Economic Cost Concepts
- Private cost
- Social cost
Private cost refers to all expenses spent by a company for day to day purpose that is called private cost.
Social costs are expenses spent by managers for society that are called social costs. Social cost is the sum of Private cost and external cost.
Different cost curve
- Fixed cost curve
- Variable cost curve
- Total cost curve (Mother Curved Production)
- Average cost curve
- Marginal cost curve
Relationship between AC and MC
Average cost curve and marginal cost curve are interrelated. However, the marginal cost curve is the change in the last unit of production whereas the average cost curve is the average of all the costs of production.
So,the MC curve begins first when it is at the minimum point a curve pulls it up and both of them move together representing a strong production function between input and output.
Relationship between TC and MC
- MC is calculated from total cost; it is the difference between total cost of two successive units.
- When total cost (TC) price and diminishing rate then MC is declining.
- When the rate of TC diminishes then MC is minimum.
- PC starts rising at an increasing rate then MC also starts rising.
Relationship between AC, MC, AFC, AVC
- MC cut AC at its minimum point.
- AFC falls continuously and slowly when the output is large it starts going down and parallel to X access.
- AVC is “U” shaped and the gap between AC and AVC is declined as output increases.