Some inputs are used over a period of time for producing more than one batch of goods.
Determinants Of Short –Run Cost
Fixed
cost: Some inputs are used over a
period of time for producing more than
one batch of goods. The costs incurred in these are called fixed cost. For
example amount spent on purchase of equipment, machinery, land and building.
Variable
cost: When output has increased the
firm spends more on these items. For
example the money spent on labour wages, raw material and electricity usage.
Variable costs vary according to the output. In the long run all costs become
variable.
Total
cost: The market value of all resources
used to produce a good or service.
Total
Fixed cost: Cost of production remains
constant whatever the level of
output.
Total Variable cost: Cost of production varies with
output.
Average cost: Total cost divided by the level of output.
Average variable cost: Variable cost divided by the
level of output.
Average fixed cost: Total fixed cost divided by the level of output.
Marginal cost: Cost of producing an extra unit of output.
Short Run Cost Output Relationship
Fixed cost curve is a horizontal
line which is parallel to the ‘X’ axis. This cost is constant with respect to
output in the short run. Fixed cost does not change with output. It must be
paid even if ‘0’ units of output are produced. For example: if you have
purchased a building for the business you have invested capital on building
even if there is no production.
Total fixed cost (TFC) consists of various costs
incurred on the building, machinery, land, etc.. For example if you have spent
Rs. 2 Lakhs and bought machinery and building which is used to produce more
than one batch of commodity, then the same cost of Rs. 2 Lakhs is fixed cost
for all batches. The total variable costs vary according to the output.
Whenever the output increases the firm has to buy more raw materials, use more
electricity, labour and other sources therefore the TVC curve is upward
sloping. The total cost consists of fixed (TFC) and variable costs (TVC). The
TFC of Rs. 2 Lakhs is included with the variable cost throughout the production
schedule so the total cost (TC) is above the TVC line.
The above set of graphs indicates
clearly that the average variable cost curve looks like a boat. Average fixed
cost curve declines as output increases and it is a hyperbola to the origin.
The Marginal cost curve slopes like a tick mark which declines up to an extent
then it starts increasing along with the output. Let us see and understand the
nature of each and every curve with an example. The table and graphs shown
below indicates the total costs curves and average cost curves at various
output level.
From the above table and set of graphs we can
understand that capital is the fixed factor of production and the total fixed
cost will be the same Rs. 300,000. The total variable cost will increase as
more and more goods are produced. So the total variable cost TVC of producing 1
unit is Rs.1500 000, for 2 units 1700 000 and so on.
Total cost = TFC + TVC for 1 unit TC = 300 + 1500 = 1800.
The marginal cost of producing an extra unit is
calculated based on the difference in total cost.
MC for 5th unit =
TC of 5th unit
minus TC of 4th unit, in
our example 2600 – 2250 = 350.
AVC also is calculated in the same manner TVC / output = 2600 / 5 = 460
AFC = TFC / output = 300 / 5 = 60.
Tags : Managerial Economics - Cost Analysis
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