Presented to:Sir Ahmed Ghazali

Group Members:Hassam Khalid 13024854-009M. Mansha 13024854-001Faisal Naseer 13024854-048Atif Afzal 13024854-064Muhammad Waqas 13024854-050

Cost Theory and Analysis

The expenditure incurred to produce an output or

provide service

Thus the cost incurred in connection with raw material, labour, other heads constitute the overall cost of production

What is Cost

Accounting Cost

Economic Cost

Variable Cost

Types of Cost

All those expenses that incurred during

production with adjusted depreciation is called accounting cost.

Cash payments which firms make for factor and non-factor input depreciation other book keeping entries.

Accounting Cost

Economic costs includes the payments such as rent,

wages, interest and profit, which are paid to factors of production – land, labour, capital and entrepreneur for their services.

Economic Costs = Accounting Costs + Implicit Costs

Economic Cost

Factors of production or resources, in an economy are

limited and have alternative uses. The cost of sacrifice or foregone for the next best use of resource is known as opportunity cost.

Opportunity Cost

Sunk Cost A cost that has already been incurred and thus cannot be

recovered.

Cost Function

Short Run Cost Function

Long Run Cost Function

Cost Function

Long Run Marginal

Costs (LMC)

Costs According to Time Period

Short Run Cost Curve Long Run Cost Curve

Total Cost (TC)

Average Cost (AC)

Marginal Cost (MC)

Long Run Total Costs

(LTC)

Long Run Average

Costs (LAC)

Total Fixed Costs (TFC)

Total Variabl

e Costs (TVC)

Average Fixed Costs (AFC)

Average

Variable

Costs (AVC)

[TC =TFC+TVC] [AC = AFC+AVC]

MC = TCn – TCn-1

OrMC = ΔTC ΔQ

In short-run period, some of the firm’s inputs are fixed and

some are variable, and this leads to fixed and variable costs. Fixed Cost Variable Cost Total Cost Average Fixed Cost Average Variable Cost Average Total Cost Marginal Cost

Short-Run Cost Functions

Fixed Cost

Fixed costs are those costs which do not change with the change in level of output. Variable Cost

Variable costs are the costs which change with the change in level of output when output is zero, the variable cost also zero. It will increase with the increase in level of output. E.g. electricity changes, telephone charges.

Short-Run Cost Functions

Total Cost

Total costs is the cost of all the productive resources used by the firm.

TC = TFC + TVC Average Fixed Cost

Average Fixed Cost, can be calculated by dividing total fixed cost with the level of output. As the level of output increases, the average fixed cost decreases. AFC = TFC

Q

Short-Run Cost Functions

Average Variable Cost

Average Variable Cost is the per unit cost of the variable factors of production. It can be calculated dividing total variable cost by output.

AVC = TVC Q

Average Total Cost Average cost is the total cost per unit. It can be found out as follows

Short-Run Cost Functions

Marginal Cost

Marginal Cost is an addition made to total cost by the production of one more unit of output.

MC = ∆TC ∆Q

Short-Run Cost Functions

Short-Run Cost

FunctionsQ TFC TVC TC AFC AVC ATC MC0 $60 $0 $60 - - - -1 60 20 80 $60 $20 $80 $202 60 30 90 30 15 45 103 60 45 105 20 15 35 154 60 80 140 15 20 35 355 60 135 195 12 27 39 55

Average Total Cost = ATC = TC/Q

Average Fixed Cost = AFC = TFC/Q

Average Variable Cost = AVC = TVC/Q

ATC = AFC + AVC

Marginal Cost = TC/Q = TVC/Q

Short-Run Cost

Functions

In long run all factors of production are changeable. In long run a firm can increase its capacity, equipment, machinery, land, employee, etc. in order increase output.

Long-Run Cost Curves

Long-Run Cost

Curves Long-Run Total Cost = The minimum total costs of

producing various levels of output when the firm can build any desired scale of plant: LTC = f(Q)

Long-Run Average Cost = The minimum per-unit cost of

producing any level of output when the firm can build any desire scale of plant: LAC = LTC/Q

Long-Run Marginal Cost = The change in long-run total costs per unit change in output:

LMC = LTC/Q

Long-Run Cost Curves

Long-Run Cost

Curves

Long-Run Cost

CurvesThe slope of the total revenue TR curve refers to the product price of $10 per unit. The vertical intercept of the total cost of (TC) curve refers TFC of $200, and the slope of the TC curve to the AVC of $5. The break-even with TR=TC $400 at the output (Q) of $40 units per time period at the point B.