Cost Curves

Contents:
 What is Cost?
 Short Run Period and Long Run Period
 Types of Cost in Short Run
 Relationship Between AC and MC
 Relationship Between TC and MC
 Relationship Between TFC, TVC and TC
 Relationship Between AFC, AVC and AC
 Types of Cost in Long Run
 Deriving Long Run AC from Short Run AC
 What is Cost?

Cost refers to the expenditure incurred on the

production of goods and services.

COST

On the basis of inputs used On the basis of production time

period

Fixed Costs Variable Costs

Explicit Cost Implicit Cost
 Explicit Costs Implicit Costs

1. Cost of hiring/ purchasing 1. Imputed cost of using self-

inputs from the market. owned resources.

2. Measured in terms of cash 2. Measured in terms of

payments made to the estimated costs of self owned
outsiders. and self-employed resources.

Eg. Wages paid to the Eg. Estimated Rent on

workers, electricity bills, etc. Entrepreneur’s own building,
etc.
 Fixed Costs Variable Costs

Fixed Costs are the costs Variable Costs are the costs
incurred on the fixed factors incurred on the variable
of production. factors of production.

Fixed Costs do not change Variable Costs increase with

with increase or decrease in increase in output and
output. decrease with decrease in
output.

Fixed Costs remain constant, Variable Costs are zero when

even when output is zero. output is zero.

Eg; Rent of using land, Eg; Cost of raw materials,

License Fee. electricity bills.
 Short Run Period and Long Run
Period:
 In short run period, the firm cannot change
or modify fixed factors such as plant,
equipment, scale of its organization. In
short run period output can be decreased
or increased by changing the variable
inputs like labour, raw materials etc.

 In long run period, there is no fixed factor

of production and hence there is no fixed
cost. In long run all the inputs are variable.
Costs in context of Short Run Period
and Long Run Period
 Types of Cost in the Short Run:
 Total Cost
TFC
TVC
 Average Cost
AFC
AVC
 Marginal Cost
 Types of Cost in the Long Run:
 Long Run Total Cost
 Long Run Average Cost
 Long Run Marginal Cost
Types Of Costs in Short Run:
Total Cost(TC): Sum total of fixed cost and
variable cost, corresponding to a given level of
output.
TC= TFC+TVC
 TFC: Total cost incurred on the fixed inputs.
It doesn’t change with the change in
output.
TFC= AFC*Q
 TVC: Total cost incurred on the variable
inputs. Changes with the change in output.
TVC= AVC*Q
 Total Fixed Cost

The payments which are made by the

Producer on Fixed Factors during the
process of Production are known as T.F.C.
Eg:- Payment on Building , Machinery etc
Total Fixed Cost

Q T.F.C
0 100
1 100
2 100
3 100
4 100
5 100
 Total variable cost
The payments which are made
by the Producer on Variable
Factors during the process of
Production is known as T.V.C.
Eg:- Raw Material, Labor,
Fuel etc.
 Total variable cost
Q T.V.C
0 0
1 50
2 80
3 100
4 200 o.
5 370
Total Cost
It refers to the Total Expenditure which is paid on
Fixed and Variable Factor during the process of
Production.
TC = TFC + TVC
When,
Q=0
TC =
TFC
TVC =
0
 Total Cost
Q T.F.C T.V.C T.C

0 100 0 100

1 100 50 150

2 100 80 180

3 100 100 200

4 100 200 300

5 100 370 470

 Average Costs(AC): Cost per unit of output
produced.
AC= AFC+AVC
Or, AC= TC/Q

 AFC: Fixed Cost per unit of output produced.

AFC = TFC/Q
 AVC: Variable cost per unit of output produced.
AVC =TVC/Q
 Average Fixed Cost

It refers to Per Unit Fixed Cost

of Production.
Q T.F.C A.F.C
AFC = TFC / Q 0 100 -
1 100 100
2 100 50
3 100 33.3
4 100 25
5 100 20
AVERAGE VARIABLE COST

It refers to per Unit Variable Cost of

Production.
Q T.V.C A.V.C
AVC = TVC / Q
0 0 -
1 50 50
2 80 40
3 100 33.3
4 200 50
5 370 74
 AVERAGE COST

 It refers to per unit Cost of Production.

AC = TC / Q
 AVERAGE COST

Q T.F.C T.V.C T.C A.C

0 100 0 100 -
1 100 50 150 150
 It refers to per unit Cost of Production.
2 100 80 180 90
3 AC = TC 100/Q 100 200 66.6
4 100 200 300 75
5 100 370 470 94
 Marginal Cost

It refers to an additional cost which can be derived by producing one

more unit of output.
MC = TCn – TCn-1

Q T.C M.C
0 100 100
1 180 80
2 240 60
3 280 40
4 350 70
 Marginal Costs(MC): Additional Cost owing to
the production of an additional unit of output.
MC= TCn – TCn-1
Or, MC= ∆TC
 MC Curve is U-Shaped.
Relationship between AC & MC

Both MC & AC are derived

from TC.
Relationship between TC & MC
Relationship Between TFC, TVC & TC
• TC= TFC+TVC
• TFC is constant at
all levels of output.
• TVC increases as
output increases.
• TC is Parallel to
TVC. ( It shows
the difference
between TC and
TVC is constant i.e
TFC)
Relationship between AFC, AVC, & AC
1. AC= AFC+AVC
2. AFC is a
Rectangular
Hyperbola
3. AC tends to be
closer to AVC
with increase in
output.
Types of Costs in the Long Run:
 Long Run Total Cost
 It can be defined as the minimum cost of
producing different level of output in a long
run.
 Long Run Average Total Cost
It can be defined as the minimum per unit cost of
producing different level of output in a long run.
 Long Run Marginal Cost
• The change in the long-run total cost of producing a good or
service resulting from a change in the quantity of output
produced.
• Unlike the Short Run, in which at least one input is fixed,
there are no fixed inputs in the long run. As such there is only
variable cost. This means that long run marginal cost is the
result of changes in the cost of all inputs.
Deriving Long Run Average Cost
Curve from Short Run Average Cost
Curve:
U-shape of the short-run average cost curve is explained
with the law of variable proportions. But the shape of
the long-run average cost curve depends upon the
returns to scale. Since in the long run all inputs including
the capital equipment can be altered, the relevant
concept governing the shape of this long-run average
cost curve is that of returns to scale.
more specialized and efficient form of all factors, 
Introduction of great degree of Division of labour
Indivisibility of Factors:

Why does LAC Rise Eventually: Diseconomies of

Scale:
After a certain sufficiently large size these inefficiencies of
management more than offset the economies of scale and
thereby bring about an increase in the long-run average cost
and make the LAC curve upward-sloping after a point.
Long-Run Average Cost Curve in Case of
Constant Returns to Scale
 Conclusion
 We got to know,
1. Cost actually means the sum total of expenses
incurred in production.
2. Marginal Cost is the reciprocal of Marginal
Product.
3. During the short period of time, the producer
can control only the variable cost. Hence, he
must cover at least variable costs.
4. During the long period, the producer must
cover all costs.