Cost Analysis

COST ANALYSIS

 Meaning of cost  Types

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- Economic Costs Outlay cost – Actual financial expenditure. Opportunity cost, Pecuniary cost, Social (opportunity) cost Explicit cost– Direct contractual monetary payments incurred through market transactions. Implicit cost – Opportunity cost of owners’ own assets. Production cost & Selling costs Real cost & money cost Incremental cost – Total additional expenditure associated with the expansion of output. Short run costs & long run costs - Accounting Costs Capital costs, Overhead costs (indirect), Direct costs, Period costs Out-of-pocket cost & Book costs Replacement cost & Original / Historical cost

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Avoidable & Unavoidable cost Direct & Indirect cost ( Traceable / Assignable Cost and NonTraceable / non-assignable cost) Present Vs Future costs

- Engineering Costs   

Planning costs Execution costs Operation costs

 Short run costs Fixed cost / Supplementary cost – Costs that are incurred on

fixed factor input. They remain fixed at any level of out put. Variable cost / Prime cost – Cost incurred on the variable factor inputs. They vary directly with the level of output.

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Behavioural Costs Total cost Total Fixed cost – TFC remains constant at all levels of output,

thus independent of output. Total variable cost – TVC varies with the output, thus directly dependent on output. * TVC initially increases at a decreasing rate, but after a point it increases at an increasing rate. ( Law of variable proportion)

Total cost – TC varies in the same proportion as the TVC Per unit cost - Average cost Average Fixed cost – Per unit fixed cost * As the output increases the TFC gets spread over a larger output and hence AFC goes on progressively declining.AFC curve is rectangular hyperbola. It approaches both the axes asymptotically I.e., it gets very close to both the axes but never touches them. * The product of AFC with the output for any given level of output at that level always remains same. Average variable cost – Per unit variable cost * AVC declines initially, reaches its minimum and then begins to rise sharply. AVC is slightly U shaped. Average total cost – Per unit total cost *If the output of the firm is increased, ATC decreases initially up to a point, then remains constant for a while & thereafter starts rising. AC assumes U shape. ( declining phase, constant phase and rising phase)

Marginal cost – MC is the rate of change in the total cost when the output is increased by one unit. (The cost of producing the last unit) - In short run MC is independent of FC & is directly related to the VC. Mc curve also assumes U shape.  Relationship between marginal cost and average cost - When AC is falling, MC is also falling and AC>MC i.e., When both MC and AC are falling, MC curve lies below the AC curve - At certain stage MC starts rising but AC continues to fall, AC is still above the MC. - When AC is minimum, MC=AC i.e., MC intersects AC at its lowest point. - When both Ac & MC are rising, MC>AC i.e., AC curve lies below MC.  Area underlying the unit costs

- The point on each average cost curve measures the average cost,

but the area underlying them denotes total cost as under. - Area underlying AFC curve measures the total fixed cost.

 Long run costs In the long run, all costs are variable cost. There is no dichotomy of total cost into fixed and variable costs. Long run average cost curve: It is an envelope of various SACs. -- Features - It is a tangent curve - It is an envelope curve - It is a planning curve - It is a minimum cost combination curve - It assumes flatter U shape Long run marginal cost curve : It is derived from the slope of total cost curve at various points relating to the given output each time. This curve also assumes flatter U shape.  Relationship between LAC and LMC Same as in the case of SAC and SMC