Cost Analysis

Cost Analysis Introduction Before understand the all cost concept we should have to understand the meaning of cost. Cost is normally considers from the producer’s or firm’s point of view. For the production of any commodity producers are using the help of many things, we called factors of production and that is land, labour, capital and entrepreneur. Producer should have to give reward to these factors. So to land pays rent, to labour pays wages, to capital pays interest and profit to the entrepreneur. And other important thing is that other expenses for the produce the commodity if it is there for the production like raw material, and any other cost. Other concept is also there like cost is the total expense before selling the product without adding the profit. In short cost is the amount paid to the factors of the production. In other simple word we can say cost is the total expense to produce any commodity or product. Various Cost Concepts Every firm wants to maximize their profit or minimize losses they have to consider two things. (1) Increase the price of the product (2) Decrease the Cost of the product Price can be change in only one way but cost is difficult because all cost has not a same kind of nature. So there is a need to understand the nature of the cost. As per the nature of the cost there are different cost concept derived. It is helpful to understand the cost and as per their nature producers can control over the cost and they can minimize the cost. Money Cost: Money cost means the aggregate money expenditure incurred by a firm for the production of the commodity. For example wages, salary, rent, interest etc. if any expense occurred but is not calculated in term of money, that cost should not consider as a money cost. Real Cost: The real cost means the cost of real work or efforts involved directly or indirectly in the production of the commodity. In other word we can say real cost is money cost plus extra efforts for the production of commodity. It can be in term of money or it can not be. As per Prof Marshall real cost is “The exertions of all the different kind of labour that are directly or indirectly involved in making it; together with the abstinence or rather the waiting required for saving the capital used in making it, all these efforts and sacrifices together will be called the real costs of production of that commodity.” Opportunity Cost The opportunity cost of any commodity is the best alternative commodity that is sacrificed of foregone. For example Money is used for the production of the car could be used for the production of any other product like machinery or bike or scooter etc.

Note: if in exam question ask for this and if its more than 3 marks you should write its limitation also it is the book (elements of economics by R C Joshi, page no. 133) Short run and Long run The short run is a period of time in which output can be increased or decreased by changing only the amount of variable factors such as labour, raw materials etc. In the short run, quantities of fixed factors such as capital equipment, factory buildings, top management etc. Long run is a period of the time on which quantities of all factors – fixed as well as variable can be changed. Thus in the long run, output can be changed not using more quantities of labour and raw materials but also by expanding the size of capital equipment or buildings new plant with larger production capacity. Fixed Cost Fixed costs are those items of expenditure which are not affected with output of the production. They do not change with the change in output. If there is zero production but that cost is occurred. But in long run it can be changed. In simple word fixed cost is fixed and it is not change with the output. For example: Rent for the building. Interest on loan Depreciation on machineries Salary Insurance premiums Property and business tax (note: not write WAT and sales tax here) From the above diagram we can

understand the fixed cost To X axis the output and to Y axis Fixed cost is there.

FF is the fixed cost curve it is parallel to X axis because fixed cost remain unchanged with out put. When output A, B or C it is same. As we know the term sort run and long run. Fixed cost remains same in the short run but in long run all cost can be changed so fixed costs are not fixed permanently. To increase the production in long run firm will have to increase its plant, to purchase new machinery etc. Variable Cost Variable costs are those cost which very or change with output. So if output is zero the cost is zero and if output increased the cost will be increased. Variable costs are also known as direct cost which can be changed in short run as output changes. For example: Cost of raw materials Wages of labour Power Excise, sales tax Transport etc/

In this diagram OV is the Variable cost curve. You can see at the point O it is zero and as the output increases the cost also increases. At OA level it is AE, OB level it is BF and OC level it is CG. Semi-variable Costs Semi-variable costs are those cost which is not totally fixed or not variable. It is partly fixed and partly variable. For example Telephone Bill (rent fixed and charges per call) Electricity Bill etc.

Total Cost Total cost is the sum total of fixed cost and Variable cost. Total Cost = Total Fixed Cost + Total Variable Cost TC= TFC+TVC

In this diagram , the total cost curve TC has been obtained by adding total fixed cost curve (TFC) and total variable cost curve (TVC) because total cost means total of fixed and variable cost. As said earlier TC=TFC+TVC Relation Between Marginal Cost and Average Fixed Cost, Average Variable Cost and Average Total Cost. The relation between Marginal Cost and Average Fixed Cost, Average Variable Cost and Average Total Cost shall be clear from a study of the following diagram.

From the above diagram we can clarify following points to explain the relationship between Marginal Cost and Average Fixed Cost, Average Variable Cost and Average Total Cost. (1) There are four curves in the diagram. MC is the marginal cost curve, ATC is the Average Total Cost curve, AVC is the Average Variable Cost curve and AFC is the Average Fixed Cost curve. (2) A is the point where MC curve cuts the AVC and B is the point where MC curve cuts the ATC. (3) Average Fixed cost curve (AFC) is a downward sloping curve in the shape rectangular hyperbola. Because as the out put increases the average cost decreases. It will never touch the Y axis because average always calculated with at least one unit. And it will never touch X axis because average fixed cost can not be zero. (4) Average Variable Cost curve (AVC) at first falls and then rises because as we know at the starting of any business it is not utilized 100% capacity so up to normal capacity is it falls down and then it starts to increase the curve. (5) Average Total Cost curve (ATC) which is the sum total of Average fixed cost and average variable cost curves is a U shaped curve. (6) Marginal Cost curve (MC), after showing an initial fall it rises continuously thereafter. The curve is same like AVC but its little different. (7) Between Average fixed cost curve and Marginal cost curve there is no clear relationship because as we know that Marginal cost always change with the Variable cost in short run but in long run all cost is a variable so we can say in short if there is a fixed cost no relationship with the marginal cost. (8) And there is a relationship with the average variable cost curve (AVC) and average total cost curve (ATC). We can see in the diagram point A where marginal cost curve (MC) cuts the AVC and point B where MC cuts the ATC. Where lowest point of both the curves. In short we can say there is a clear relationship with between Marginal Cost and Average Variable cost and Marginal Cost and Average Total Cost, and no definite relationship between Marginal Cost and Average fixed Cost.