Cost of production : Expenditure incurred on various inputs to produce goods and services.
Cost function : Functional relationship between cost and output.
Where f=functional relationship
c= cost of production
q=quantity of product
Money cost : Money expenses incurred by a firm for producing a commodity or service.
Explicit cost : Actual payment made on hired factors of production. For example wages paid to the hired labourers, rent paid for hired accommodation, cost of raw material etc.
Implicit cost : Cost incurred on the self - owned factors of production.
For example, interest on owners capital, rent of own building, salary for the services of entrepreneur etc.
Opportunity cost : is the cost of next best alternative foregone / sacrificed.
Fixed cost : are the cost which are incurred on the fixed factors of production.
These costs remain fixed whatever may be the scale of output. These costs are present even when the output is zero.
These costs are present in short run but disappear in the long run.
Numerical example of fixed cost
TFC = Total Fixed Cost
Diagrammatic presentation of TFC
TFC is also called as “overhead cost”, “supplementary cost”, and “unavoidable cost”.
Total Variable Cost: TVC or variable cost – are those costs which vary directly with the variation in the output. These costs are incurred on the variable factors of production.
These costs are also called “prime costs”, “Direct cost” or “avoidable cost”.
These costs are zero when output is zero.
Difference between TVC & TFC
Total cost : is the total expenditure incurred on the factors and non-factor inputs in the production of goods and services.
It is obtained by summing TFC and TVC at various levels of output.
Relation between TC, TFC and TVC
Average cost : are the “cost per unit” of output produced.
Average fixed cost is the per unit fixed cost of production.
AFC = TFC / Q or output
AFC declines with every increase in output. It’s a rectangular hyperbola. It goes very close to x axis but never touches the x axis as TFC can never be zero.
Average variable cost is the cost per unit of the variable cost of production.
AVC = TVC / output.
AVC falls with every increase in output initially. Once the optimum level of output is reached AVC starts rising.
Average total cost (ATC) or Average cost (AC) : refers to the per unit total cost of production.
ATC = TC / Output
AC = AFC + AVC
Phases of AC
I phase : When both AFC and AVC fall , AC also fall
II phase : When AFC continue to fall , AVC remaining constant AC falls till it reaches minimum.
III phase : AC rises when rise in AVC is more than fall in AVC.
Important observations of AC , AVC & AFC
Marginal cost : refers to the addition made to total cost when an additional unit of output is produced.
MCn = TCn-TCn-1
MC = ΔTC / ΔQ
Note : MC is not affected by TFC.
Relationship between AC and MC
Important formulae at a glance