Final COst

Managerial Economics Cost Concepts

MANAGERIAL ECONOMICS

Cost Concept

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ACKNOWLEDGEMENT

We the members of the group would like to thank Prof. Pandey for helping us to prepare this project. It is because of your guidance and support we could get the required information and compile it into a project form and hereby submit this work. Thank you for your valuable time and effort.

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GROUP MEMBERS

Swati Tikku 95

Pooja Patil 71

Hardik Gohel 114

Riten Sakhiya 117

Sagar Sangani 110

Rajdeep Pandere 102

Aftab Khan 113

Jaiveer Duggal 128

Presented By the students of F.Y.B.M.S. (B)

College -Bhavan’s CollegeProfessor - Prof. Pandey

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INTRODUCTION

A) MEANING OF COST: For layman, cost of production means money expenses incurred by a firm on production of a commodity but in economics sum of explicit costs and implicit costs constitutes total cost of production of a commodity. We have seen that human are satisfied by way of goods and services which are produced by firms. For producing a commodity, a firm requires factor inputs and non factor inputs. The money spent by the firm on both factor inputs and non factor inputs is called money cost. In economics money expenses alone do not constitute cost of production because it does not include the imputed cost of self owned factors supplied by the firm itself. For an economist this hidden cost of self supplied factors also forms a part of cost of production. Thus in economics sum of explicit cost and implicit cost constitutes total cost of production of a commodity. Different concepts relating to cost are shown in the following chart and discussed thereafter.

TYPES OF COST

EXPLICIT IMPLICIT MONEY REAL OPPORTUNITY PRIVATE SOCIAL

B) EXPLICIT COST AND IMPLICIT COST: “EXPLICIT COSTS AND THOSE CASH PAYMENTS WHICH FIRMS MAKE TO OUTSIDERS FOR THEIR SERVICES AND GOODS” - LEFTWITCH. These costs are recorded in firm’s account book. we know that for producing a commodity, a firm incurs expenses on hiring factor inputs (like services of land, labour , capital) and on buying non-factor inputs (like raw material, power etc). For e.g. a firm gets land on lease and pays rent. It hires labour and pays them wages .it borrows money and pays interest. Similarly it

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spends money on transportation, raw material, insurance premium, fuels, advertising and on making up depreciation of machinery. All these money expenses are known as explicit costs of production. Mind, these costs include payments made to others and not to the owner himself for self-owned, self-supplied resources. “IMPLICIT COSTS ARE COSTS OF SELF-OWNED OR SELF-EMPLOYED RESOURES” – LEFTWITCH. These are estimated value of inputs supplied by the owner of the production unit himself. For instance, an entrepreneur may utilize his own building or his own capital or may act as a manager of his firm himself. for these productive services, he does not pay rent or interest or salary to himself although the payments accrue to him. These are, in a way, implicit rewards or imputed costs of various factors owned and supplied by the owner himself. Main difference between the two costs is that in explicit cost payment is made to others whereas in implicit cost, payment becomes due to his own factors of production.

IN ECONOMICS SUM OF EXPLICIT COSTS AND IMPLICIT COSTS CONSTITUTE THE TOTAL COST OF PRODUCTION OF A COMMODITY.

C) MONEY COST AND REAL COST

Money cost of production refers to the money expenditure incurred on hiring and buying of inputs for producing a given amount of commodity.

According to MARSHALL ,”Money cost measures the amount of money which a producer spends on producing a particular commodity”. For example, all money expenditure in the form of rent, wages, etc. and money spent on non factors inputs like raw materials ,transport, advertising, insurance charges, power, fuel etc. are included in money cost . If a producer spends Rs. one lakh in manufacturing 100 transformers, then its money cost will be taken as Rs. One lakh.

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Money cost is further subdivided into two parts namely fixed cost and variable cost.

Real cost refers to the sacrifice, discomfort, toil and pain involved in supplying the factors of production by their owners . money paid for hiring a factor or its owner in producing a commodity is real cost. Since elements like sacrifice, pain and discomfort are subjectives. It is therefore difficult to measure the real cost for instance, abstinence and sacrifice involved in saving and accumulation of capital or pain and discomfort felt by the labourers in the production of goods abd indicators of real cost which cannot be measured.

D) OPPORTUNITY COST

The opportunity cost of an activity is equal to the value of next best alternative foregone.

Alternatively, it is the cost in terms of the alternative foregone. We know resources are not only scarce but have alternative uses also. Therefore a particular resource can be put to different uses simultaneously. For instance, suppose an economy has a limited stock of coal which can be used either for running railways steam engines or for generation of electricity called thermal power. In other words, we can say that cost of running railways steam engines is so many kilowatt of thermal power which could have been generated instead with the same quantity of coal.

In the context of factor income, opportunity cost indicates what a factor could earn in the next best use. One has to forgo something for getting something and what is given up for getting something Is called the opportunity cost of that thing. For example, a clerk gets Rs. 800 per month for giving private tuition after office hours but for that he

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forgoes Rs.500 which he would have got for working overtime after office hours.

IMPORTANCE-

The concept of opportunity cost is very important in the context of factors of production. Since supply of factors is scarce and can be put to alternative uses, therefore a factor can be utilized in one use sacrificing its use for other purposes. Further it helps economists to know how limited resources get allocated in different branches of production.

E) Private Cost and Social Cost

Private costs refer to the cost incurred by an individual firm in producing a commodity. It is infact the money cost which a firm incurs on hiring and purchasing inputs for producing a commodity. This cost has nothing to do with the society.

Social cost refers to the disadvantages of producing a commodity suffered by the society as a whole. It does not take into consideration money cost but something like cost in the form of disadvantages which are borne by the society directly or indirectly. For instance, the society pays social cost in the shape of health hazards connected with air pollution when buses and cars emits smoke while plying in the interior of big cities.

F) Short Run Cost

There is a difference between short run costs and long run costs of production. In short run some factors (like machinery, building, technical labour) are fixed which cannot be changed due to

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insufficiency of time while others (like ordinary labor, raw material, power etc.) are variable which can be changed according to the output to be produced. Accordingly, costs are divided into fixed cost and variable cost.

G) Fixed Cost

Fixed costs are the cost which do not change with the change of level of output. Production may come down to zero or be doubled, fixed cost remains the same. These have to be borne even if no output is produced. For instance, a sugar mill will usually remains closed for about three months during a year for want of raw material but still the mill owner has to incur certain cost like rent of factory building, interest in past borrowing, salaries of permanent employees, municipal taxes, etc. These are also called supplementary cost or overhead cost.

Since total fixed cost remains the same at all levels of output TFC curve is a straight line parallel to X axis.

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H) Variable Cost

These are the costs which vary directly with the change in the level of output. Such cost increase when output increases and decreases when

output falls. That is why they are direct cost since they vary directly with the change in the level of output. The cost incurred on raw material, fuel, wages of temporary labor, wear and tear of machinery etc. are examples of variable cost. It is also called as prime cost or direct cost.

The TVC curve is upward sloping which indicates that total variable cost go on increasing with increase in output.

Importance – The significance of distinction in cost lies in the fact that when a firm in incurring losses, it still continues its production if the market price covers at least its variable costs during short period. In other words, the firm will be ready to incur losses equal to fixed cost rather than stop production in the short period. However, in the long period, market

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price must cover firm’s fixed and variable cost otherwise firm will stop production.

Distinction between Fixed Costs and Variable Costs

1. FC do not increase or decrease with increase or decrease in level of output.

1. VC change with changes in the level of output.

2. FC are related with fixed factors which cannot be changed during short period.

2. VC are related with variable factors capable of being changed during short period.

3. FC can never be zero even when production is stopped.

3. VC is zero (nil) when production only when VC are met.

4. Production may continue even at the loss of FC during short period.

4. A firm continues production only when VC are met.

5. FC curve is parallel to X-axis.

5. VC curve moves up from left to the right.

6. FC are present only in short period.

6. In the long run, ail costs are the variable costs.

Fixed costs and variable costs constitute total cost of production. These are formally called total fixed costs, total variable costs and total costs respectively.

Explain the following:

Total fixed cost (TFC), Total variable cost (TVC), Total cost (TC).

TFC, TVC & TC Curves.

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Ans. There is difference between short period cost and long period cost of production. Short-run production is governed by law of variable proportion because plant of a firm being fixed, production can be changed by changing variable factors like labour, raw material, etc. Short period cost basically consists of fixed cost and variable cost whereas long period cost refers to average cost (AC) and marginal cost (MC) because there is no distinction

between fixed cost and variable cost in the long run. Again in short period TFC remains the same but AFC falls with every increase in volume of output. On the other hand, TVC changes according to volume of output affecting AVC.

(a)TFC , TVC , TC

(i) Total fixed costs are the costs which remain the same at different levels of production. Since TFC Remains constant irrespective of the size of output, TFC curve is parallel to X-axis.

(ii) Total variable costs are sum of the cost of which vary directly with the size of output produced. Such costs change with change in level of output. In other words, total variable costs go up as output is increased and fall as output in decreased. TVC is zero at output. Remember, rate of increase in TVC depends upo which phase of ‘law of returns to a variable factor’ is in operation. Briefly TVC increases at a decreasing rate in the beginning, then at a constant rate and finally at an increasing rate making TVC curve concave in its shape.

(iii) Total cost of production. It is the cost of production of all the units of a commodity produced by a firm. TC is sum of TFC and TVC,

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TC = TFC + TVC


The following imaginary schedule of a firm indicates TC, TFC, TVC and their relationship. Mind, at zero level of output TC = TFC because TVC is zero.

Quantity of Output (units) TFC (Rs.) TVC (Rs.) TC (Rs.)

0 100 0 1001 100 50 1502 100 70 1703 100 80 1804 100 105 2055 100 135 2356 100 170 270

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Quantity of Output

Cost

TC

TVC

TFC

TFC


It can be seen from the table that TFC is constant at Rs. 100 whether output is zero or 6 units. On the other hand, TVC is zero output and increases. Since TFC is constant, TC exceeds TVC by amount of TFC.

(b)Relationship between TFC, TVC, TC curves

TFC, TVC, TC curves. Remember, an increase in TC indicates an increase in TVC only since TFC remains same irrespective of quantity of output produced.

(i) TFC curve is horizontal and parallel to X-axis. The reason is that TFC is fixed or constant and remains the same (Rs. 100) at all levels of output.

(ii) TVC curve and TC curve are upward sloping because TVC and TC increase with increase in output.

(iii) Total cost curve is vertical summation of total fixed cost curve and total variable cost curve.

(iv) Again at zero level of output, TC is equal to TFC because there is no variable cost.

After that, change in TC is entirely due to change inn TVC. Consequently TC curve and TVC curve have similar shape except that TVC curve starts from zero level of output whereas TC curve starts on Y-axis from a point having distance equal to FC. As the vertical distance between curves remain parallel to each other. Graphically TC curve is vertical summation of TFC and TVC curves.

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1) Average Fixed Cost – It is the per unit cost of producing a commodity. It is calculated by dividing the total fixed cost by the number of units of commodity produced. For example, if total fixed cost of manufacturing fans is Rs. 7,500, then:

AFC = 7500 = Rs. 75

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Beware that fixed cost (i.e., total fixed cost) remains fixed or same at different levels of production.

2) Average Variable Cost – It is the per unit variable cost of producing a commodity. It is worked out by dividing the total variable cost by the number of units produced. For instance if total variable cost of manufacturing 100 fans is Rs. 12,500, then:

AFC = 12,500 = Rs. 125

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AFC = Total Fixed Cost No. of units produced

AVC = Total Variable Cost No. of units produced


100

It should be kept in mind that in the beginning AVC decreases but after reaching the stage of minimum cost, it starts increasing, AVC curve is a dish shaped (U-shaped) curve.

3) Average Total Cost – It is per unit cost of production of a commodity. It is worked out by dividing the total cost (fixed cost + variable cost) by the number of units produced. Continuing the above example if total cost of manufacturing 100 fans is Rs. 20,000 (fixed cost 7,500 + variable cost 12,500), then:

AFC = 20,000 = Rs. 200

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Like total cost which is the sum of total fixed cost and total variable cost, ATC is also the sum of AFC and AVC. Symbolically:

ATC = AFC + AVC

For instance, in the above example AFC = Rs. 75 and AVC = Rs. 125 whereas ATC = Rs. 200 (75 + 125). In order to find out profit (or loss) of a firm, it is necessary to know the average of both fixed and variable costs combined. It is average of total cost of a firm.

Again short period costs are further illustrated on the next page with the help of the following cost schedule of any imaginary firm. (Mind, at zero level of output, TC is equal to TFC)

Cost Schedule of an Imaginary Firm

Quantity TFC TVC TC AFC AVC ATC MC

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ATC = Total Cost No. of units produced


(units) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)0 120 0 120 - - - -1 120 60 180 120 60 180 602 120 80 200 60 40 100 203 120 90 210 40 30 70 104 120 110 230 30 27.5 57.5 205 120 150 270 24 30 54 406 120 240 360 20 40 60 90

4) AFC, AVC and ATC curvesAll the three average costs have been depicted below. AVC and ATC

curves do not intersect because difference between the two is AFC which can never be zero. Thus positive value of AFC keeps the AVC and ATC curves apart.

Y

Cost

O Output X

5) Nature of Shape of TFC Curve and AFC Curve

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ATC

AVC

AFC


i. As far as shape of Total Fixed Cost (TFC) curve is concerned, it is always parallel to X-axis because TFC remains the same whether production is doubled or brought to zero.

ii. Shape of AFC curve is downward sloping curve from left to the right. Its reason is that average fixed cost goes on falling with every increase in output. Again AFC always remain positive nor touches Y-axis because AFC curve neither touches X-axis because AFC approaches infinity when production is zero. Thus AFC curve assumes the shape of rectangular hyperbola with its area defined by total fixed cost.

6) Relationship between ATC, AVC and MC Curves.Let it be reminded that both MC and AVC are derived from total

variable cost (TVC). The point to be kept in mind is that during short period, since fixed costs do not change, it is only variable costs which vary (change) with output. Therefore marginal costs are in fact due to changes in variable costs. It also means changes in fixed costs do not affect MC

The figure below depicts the relationship between ATC, AVC and MC curves.

Cost

Output

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Y

X

O

ATC

AVC

A

B

Y X


We know that it is production function which determines ATC, AVC, and MC. From the above figure, it is clear that AVC, ATC, and MC curves fall up to a point and then start rising. In other words, they are U-shaped which is explained by three stages of operation of law of variable proportion. (i)MC curve falls faster than AVC curve and also rises faster than AVC curve. (ii) MC curve intersects AVC and ATC curves at their minimum points. (iii) Vertical distance between AVC and ATC curves is declining continuously. ATC and AVC curves do not intersect each other because the difference between ATC and ATC is AFC which is always positive (more than zero). Thus positive value of AFC keeps the ATC and AVC curves apart.

7) Relationship between AVC and MC Curvesi. When AVC is falling, MC is less than AVC (Diagrammatically when AC

curve falls, MC curve falls, and MC curve lies below AVC curve till their intersection at point in the above diagram).

ii. When AVC is minimum, MC is equal to AC (Diagrammatically the point where MC curve intersects AVC curve, is the minimum point of AVC).

iii. When AVC is rising, MC is more than AVC. (Graphically MC curve lies above AVC curve after point of intersection.)

Relationship between AVC and MC with the help of a diagram is shown in the above diagram.

8) Area under MC curve = TVCWe have seen that MC is addition to the total variable cost when an

additional unit is produced. This means that total variable cost (TVC) is the sum of marginal costs because total fixed costs remain the same in short period. This is provided in the below figure. Assuming output perfectly divisible, a hypothetical smooth MC curve is drawn in the below figure. We know that TVC is simply the sum of marginal costs of number units produced. Thus under the assumption of smooth marginal costs curve, total variable cost (TVC) is equal to the area under marginal cost curve. For

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instance at OQ units of output, TVC is equal to the shaded area OABQ in the diagram.

9) Rising portion of MC curve is the supply curve itself.How? Recall that the basis of law of supply or supply curve is

increasing marginal cost. In the figure on the next page, MC curve is U-shaped and P1 is the price line under perfect competition. At the price P1, the price line cuts MC curve at two points – at Qa

1 and Qb1, i.e., it satisfies profit

maximizing condition P = MC at two places. But total profit at output level of Qb

1 is higher. Therefore at price P1, the firm produces the amount Qb1. It

means that if price is OP1, the firm will supply OQb1 level of output. Similarly

if price is OP2, the firm will supply (produce) OQ2, level of output and at price OP3, it would supply (produce) OQ3, level of output; and so on. We see clearly that all price-output combinations are simply the points on the rising portion of MC curve. Hence it is concluded that the rising portion of MC curve is the supply curve itself.

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MC

O

TVCTVC

A

QOUTPUT (UNITS)

MC/

TVC

(RS.

)

Y

XO

MC

P1

P2

P3

Qa1 Qb

1 Q2 Q3

PRIC

E

OUTPUT

X

B

Y


10) Average Cost – It is per unit cost of production of a commodity. According to Ferguson, “Average cost is total cost divided by output”. AC is calculated by dividing the total cost by the number of units produced. Suppose the total cost of production of 25 chairs is Rs. 2,500. In this case cost per chair or average chair would be as follow:

AC = 2,500 = Rs. 100

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11) Reason for AC curve being U-shaped?AC curve in short is a U-shaped curve due to operation of law of

returns (i.e., law of variable proportion). Remember, increasing returns imply diminishing costs, constant returns mean constant costs and diminishing returns imply increasing costs. As output is increased, AC first falls, reaches its minimum and then rises. Hence, AC curve becomes U-shaped. Minimum point of AC curve indicates lowest per unit cost or production. The point of output is also the point of optimum capacity of firm. It is being showed in the figure on the next page.

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Average Cost = Total Cost No. of units produced


12) Marginal Cost (MC)Marginal cost is the addition to the total variable cost when an

additional (extra) unit of a commodity is produced or when output is increased by one unit. In economics, marginal means additional whether it is used in the context of cost or revenue or product or even utility. Thus MC is the additional cost of producing an additional unit of a commodity. It is attributable to the addition of one more unit to the output. Continuing the above example, suppose it costs Rs. 2500 to manufacture 25 chairs and Rs. 2620 to manufacture 26 chairs. In this case MC will be Rs. 120 (2620 – 2500) which is addition to the total cost (Rs. 2500) when an additional unit (26th chair) is produced. Again remember, since MC is the additional cost, it is in fact addition to variable cost and not to fixed cost because the latter (FC) remains same in short period.

13) Reason for MC curve U-shaped?It is due to operation of law of returns. The figure below depicts

behavior of MC graphically. MC curve is also U-shaped which indicates that MC falls in the beginning, then remain constant and ultimately it rises. The reason behind U-shape of MC curve is operation of law of returns. Initially production is subject to law of increasing return (i.e., decreasing cost), the law of constant return (i.e., constant cost) and ultimately to law of

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Y

XO

COST

OUTPUT

AC


diminishing returns (i.e., increasing cost). Once we understand why MC curve is U-shaped. More, MC curve cuts AVC and ATC curves at their minimum points.

14) Relationship between Average Cost and Marginal CostThere is an apparent relationship between AC and MC since both have

been derived from total cost. It needs to be remembered that between AC and MC, it is MC which brings about changes (rise or fall) in AC and not the rises, it pulls AC up. Conversely we can also say that when average increases, marginal is more than average and when average falls, marginal is less that average. Relationship between AC and MC is summed up with the help of following imaginary cost schedule.

i. When MC is less than AC, AC falls because MC pulls AC down.ii. When MC = AC, AC is constant and at its minimum.

iii. When MC is more than AC, AC rises because MC pulls AC up.

The above relationship can be expressed conversely also in the following way:

i. When AC falls, MC is less than AC. (This is clear from first three units.)ii. When AC minimum, MC is equal to AC. (This is proved from the 4th

unit.)iii. When AC rises, MC is more than AC. (This is clear from 5th and 6th unit.)

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OUTPUT

Y

XO

COST

MC


15) Relationship between AC and MC curvesThe below diagram represents the relationship diagrammatically.

i. As long as MC is less than AC, AC curve falls and MC curve lies below AC curve till their intersection at point B.

ii. When MC curve comes to falling, it falls more rapidly and reaches its minimum point E earlier than AC curve reaches its minimum point B. Thereafter MC curve starts rising from E to B even when AC curve is still falling from D to B. (Hence AC can fall when MC is rising.)

iii. While rising, MC curve cuts AC curve at AC’s minimum point B. Thereafter, AC curve rises because MC curve lies above AC curve.

Importance – Both the concepts of AC and MC are very significant for a firm. A firm aims at maximization of its profit which is broadly the difference between total cost and total revenue. And for calculating total cost, we multiply AC with number of units produced. On the other hand, MC is important since it helps the firm to determine whether production of an additional unit be undertaken or not.

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Output (Units)

TC (Rs.)

AC (Rs.)

MC (Rs.)

1 20 20 202 38 19 183 54 18 164 72 18 185 100 20 286 150 25 50

O

Y

X

COST

OUTPUT

A

D

B

AC

MC

E


16) Relationship between Total Cost (TC) and Marginal Cost (MC)Remember, MC is the increase in TC when output is increased by a

unit.i. When TC rises at a diminishing rate, MC is declining.

ii. When rate of increase in TC stops diminishing, MC is at its minimum.iii. When TC rises at an increasing rate, MC is increasing.

17) Long Run Costs (Average Cost and Marginal Cost)

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Briefly long-run is a time period during which quantities of the entire factor inputs can be varied (changed). In other words, in the long-run all factor inputs are variable. Hence there is no distinction between fixed costs and variable costs. Therefore only long-run average costs (LAC) and long-run marginal costs (LMC) curve are mostly discussed. Following implications are noteworthy.

i. Distinction between total costs and total variable costs disappears. Simply the term ‘total costs’ is used.

ii. There is distinction between average total costs and average variable costs because of absence of fixed costs. Instead only the term ‘Long-run Average Cost (LAC)’ is used.

iii. Marginal cost is denoted by ‘Long-run Marginal Cost (LMC)’.

18) Shapes of LAC and LMC curvesFrom the below figure, it is clear that the long-run average cost (LAC)

curve and the corresponding LMC curve are approximately U-shaped. This indicates that LAC curve declines initially, then remains constant for a while and finally rises. In the adjoining figure, LAC curve is declining up to OQ output. LMC curve cuts the LAC curve at the latter’s minimum point. At the output OQ, the average cost is lowest which indicates that OQ output is the optimum output which is being produced at the lowest average cost. Constant returns prevails for a while which is indicated by flat portion in the middle of LAC curve. Production is considered most efficient at this level. Beyond OQ, as output increases, AC starts rising.

Difference – The nature of curves in the long-run and short-run is different. In the long-run, U-shape of LAC curve implies the U-shape of LMC curve whereas in short-run U-shape of Marginal Cost curve implies the U-shape of Average Cost curve. Again in the long run, U-shaped average cost curve is flatter than average variable cost curve of short-run.

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Y

XO

COST

(Rs

.)

OUTPUT (UNITS)

LMC

LAC

A

F

Q

Lowest AC

Optimum output


19) Why is LAC Curve U-Shaped?Simply put, the U-shape of the LAC curve is the result of operation of

returns to scale, i.e., a firm experiences increasing returns to scale (i.e., diminishing cost) in the beginning followed by constant returns to scale and then by diminishing returns to scale (i.e. increasing cost). It is explained below. Remember that increasing returns and diminishing costs broadly go together and that is why law of diminishing returns is called as law of increasing costs. Similarly law of diminishing returns is called as law of increasing costs.

i. It is because of increasing returns to scale that LAC curve declines initially when a firm expands production from small scale to large scale. And increasing returns to scale occur because the firm reaps economies of scale on expansion of output. Two most important economies are (i) division of labour, and (ii) volume discounts. Division of labour broadly means allocation of task according to specialisation of workers. Alternatively it is also defined as specialisation of person in particular activities. Division of labour increases efficiency, saves time and tools, enables greater machinery which reduces firm’s cost of

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production. Volume discounts refers to the discount (or rebate) on price which a firm gets on purchase of large quantities (volume) of raw material. That is bulk purchases of raw material can be made at lower prices. It leads to cost saving of a firm. Other economies are technical economies, managerial economies, financial economies etc.

ii. When AC becomes lowest as a result of increasing returns, a firm experiences constant returns for a while since production is considered most efficient at this level. Thus most efficient level of production is on at which LAC is minimum or where constant returns to scale prevail.

iii. A further increase in the scale of output beyond a certain point results in diseconomies of scale such as difficulty in management and coordination, non-availability of inputs like fuel, power and raw material, crowding and congestions etc. this leads to decreasing returns (i.e., increasing costs). It is because of decreasing returns to scale that LAC curve starts rising.In short, LAC curve first declines due to economies of scale and then rises due to diseconomies of scale. This briefly explains the U-shape of LAC curve. U-shape of LAC curve, in turn, implies U-shape of LMC curve.

20) Time element and costs.Production has its own time dimension. Therefore role of time

element in determining the costs of a firm is significant. Broadly, the following three time periods are distinguished in production or supply. This distinction is based on the basis of possibilities of making adjustments in supply.

(i) Very Short Period (Market Period). It is the period which is so short that the supply cannot be adjusted to change in demand (or price). During very short period supply is price inelastic, i.e., supply does not respond to change in price. Since supply remains almost fixed, therefore, costs have little or no influence on supply.

(ii) Short Period. It is the period during which supply can be increased only up to the maximum capacity of existing plant by using more quantities of variable factors (labour, raw material,

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power). In other words supply is inelastic beyond that point. Since supply can be increased by using the existing fixed factors, variable cost of the firm must be met during short period.

(iii) Long period. It is the period which is long enough to change the supply by changing the quantities of all types of factor inputs (fixed and variable factors). New firms can enter and old can leave the industry. Thus supply is more or less elastic. Therefore during long period all costs (fixed cost and variable cost) must be met otherwise the firm will stop producing.

BIBLIOGRAPHY

Introductory Micro Economics – C. B. Sachdeva

Managerial Economics – Vipul Publications

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