Econ: Module 13

• Production function


  One important determinant of cost of a commodity
• Price of inputs


  The other determinant of cost
• Production function together with the price of inputs


  Determines the cost of a commodity
• Cost of a commodity with a profit margin


  Determines the price of the commodity
• Supply curve interacts with demand curve


  Point of intersection gives the equilibrium price and quantity
• Costs of Production


  • One of the determinants of supply
  • Producers have greater ability and willingness to supply a product which has a lower cost of production
  • Higher cost of production results to higher price of products = affect the producers and buyers (reduce their purchases)
  • Producers have been always in the search of ways and means of cost-reduction techniques
  • Lower cost means lower price
  • Lower price means more sales – and more profits
• Cost


  Payment made to the factors of production used in the production of the commodity
• Cost function


  • Derived from production function
  • Cost is a multivariate function, i.e., it shows relationship between total cost and its determinants
• Long run cost function


  C = f (Q, T, Pf)
• Short-run cost function

  C = f (Q, T, Pf, K)
• Opportunity/alternative cost


  The cost of alternative opportunity sacrificed or given up
• Explicit cost


  The actual expenditure incurred by a firm to purchase or hire the inputs it needs in the production process
• Implicit cost


  The cost of inputs owned by the firm and used by the firm in its own production process
• Private cost


  The money cost incurred by a firm in producing a commodity
• Social cost


  The cost of producing a commodity to the society as a whole
• Fixed cost


  The cost that does not change with change in output
• Variable cost


  The costs which vary/change with the quantity of output produced
• Economic cost


  The cost to a firm of utilizing economic resources in production, including opportunity cost
• Accounting cost


  The actual expense plus depreciation charges for capital equipment
• Total cost


  • The sum total of cost of production
  • Equivalent to fixed cost plus variable cost
  • Composed of wages, rents, interests, and normal profits
• Normal profits


  The amount which is sufficient to encourage an entrepreneur to remain in business
• Pure profits


  The amount which is in excess of the cost of production
• Short-run cost


  Costs over a period during which some factors are in fixed supply, like plant, machinery, etc.
• Long-run cost


  Costs over a period long enough to permit changes in all factors of production
• Variable factors/inputs


  Labor, raw materials, electricity, oil and so forth that take a shorter time in adjusting them to the production process
• Fixed factors/inputs


  Machines, buildings, heavy equipment, or manufacturing plant capacities that take longer period of time for their adjustments in accordance with the needs of production
• Short run


  A period of time which is too short to allow an enterprise to change its plant capacity, yet long enough to allow a change in its variable resources
• Long run


  A period of time which is long enough to permit a firm or enterprise to alter its resources or inputs (both fixed and variable factors)
• Sunk cost


  The expenditure that has been incurred and cannot be recovered
• Total cost (TC)


  The total cost of production, divided into total fixed cost (TFC) and total variable cost (TVC)
• Total fixed cost (TFC)


  The cost which does not vary with the output
• Total variable cost (TVC)

  The cost that varies with the quantity of output produced
• Average cost


  Equivalent to total cost divided by quantity
• Relationship between TFC and AFC


  • AFC at any point on the TFC curve is the slope of the straight line from the origin to that point
  • To a horizontal line of TFC, showing fixed cost, AFC is a rectangular hyperbola showing decreasing fixed cost per unit as output increases
• Relationship between TVC and AVC


  • AVC at any point on the TVC curve is the slope of the straight line from the origin to that point on the TVC curve
  • As output expands, the value of slope falls continuously until maximum point of APL and beyond that the value of slope rises
  • The reason behind the shape of both TVC and AVC curves is the law of variable proportions
  • To an inverse – S shape of TVC curve, AVC is U- shaped
• Relationship between AC and AVC


  • AVC is part of AC given that AC = AFC + AVC
  • Both AVC and AC are U- shaped, reflecting the law of variable proportions
  • The minimum point of AC occurs to the right of the minimum point of the AVC
• Marginal cost (MC)


  • An addition made to the TC or TVC as output is increased by one more units
  • MC = ΔTC/ΔQ = ΔTVC/ΔQ
• Relationship between TC or TVC and MC


  • MC at any level of output is given by the slope of either the TC or the TVC curve at that level of output
  • As output expands the value of slope declines continuously and then rises thereafter
  • The reason behind the shape of the MC curve is the law of variable proportions
  • To an inverse – S shape of TC or TVC curve, MC is U- shaped
• Relationship between AC and MC


  • When MC is falling, MC is below AC
  • When AC is rising, then MC is above AC
  • When AC is neither falling nor rising, MC is equal to AC
  • There is a range over which AC is falling but MC is rising
  • MC curve cuts AC curve at its minimum point
• Relationship between MC and AVC


  • MC and AVC are the same at the first unit of output
  • MC curve passes through the minimum point of both the AVC and the AC curves
  • The area under the MC curve gives the TVC