Theory of Cost in Economics

In economics, cost theory is an important concept that deals with the production process of goods and services. It is the study of how firms make decisions regarding the allocation of resources to produce goods and services. The theory of cost is a vital component of cost theory as it provides the framework for analyzing the cost of production of goods and services.

TFC (Total Fixed Cost)

Total fixed cost (TFC) refers to the cost incurred by a firm that does not change with the level of production. TFC includes expenses such as rent, salaries of the management team, and insurance premiums. TFC is a crucial factor in determining the break-even point of a firm. The formula for TFC is:

TFC = FC (fixed cost)

TVC (Total Variable Cost)

Total variable cost (TVC) refers to the cost incurred by a firm that varies with the level of production. TVC includes expenses such as raw materials, wages, and utilities. The formula for TVC is:

TVC = VC (variable cost) x Q (quantity produced)

AVC (Average Variable Cost)

Average variable cost (AVC) refers to the variable cost per unit of output produced. AVC is calculated by dividing the total variable cost by the quantity produced. The formula for AVC is:

AVC = TVC / Q

AC (Average Cost)

Average cost (AC) refers to the total cost per unit of output produced. AC is calculated by adding the total fixed cost to the total variable cost and then dividing it by the quantity produced. The formula for AC is:

AC = (TVC + TFC) / Q

MC (Marginal Cost)

Marginal cost (MC) refers to the cost of producing one additional unit of output. MC is calculated by dividing the change in total cost by the change in quantity produced. The formula for MC is:

MC = ΔTC / ΔQ

In conclusion, the theory of cost is an essential concept in economics that helps firms to make decisions regarding the allocation of resources to produce goods and services. The formulas discussed above are used to calculate various aspects of cost, including total fixed cost, total variable cost, average variable cost, average cost, and marginal cost.

•TFC=TC-TVC
or
AFC×Q

•TVC=TC-TFC
or
AVC×Q

•AC=AFC+AVC
or
TC/Q

•AVC=AC-AFC
or
TVC/Q

•MC=∆TC/∆Q
or
∆TVC/∆Q