Cost:
Costs are an
important factor in every business decision. The cost of producing a product or
providing a service is an important consideration in the process of making a
profit. Costs can be categorized as short-run and long-run costs. Short-run
costs are incurred when creating or producing the product. These costs are
usually incurred during the design, manufacturing, and testing stages of the
product. Short-run costs include all direct and indirect expenses associated
with creating a product.
Short-run costs must be compared to short-term revenue
streams to create an accurate cost curve. In contrast, long-run costs are
incurred after a product is ready for production and sales. Long-run costs
include all direct and indirect expenses that continue after the sales of a
product. The life cycle of products can vary in length depending on their
quality and durability. Some products have limited lifetimes—short-run costs
are incurred to create these products. In contrast, other products have longer
lifetimes—long-run costs are incurred to produce these goods over time. A long
run is the lifetime of a product or service while a short run is the lifetime
of a product or service. To understand how to calculate both types of costs,
consider the example of a bottle opener that has five stages of production and
sales stages over five years (10 stages). The 10 stages include designing,
procuring raw materials, manufacturing, packaging, delivering sales promotions,
and accepting returns before paying taxes each stage results in revenues
from selling bottle openers (revenue = price × volume). Using this model, 10
sales generate 100000 dollars in revenues (total revenue = 10 × 100000
dollars). This example illustrates that short-run costs can be overlooked when
calculating total cost curves due to their high immediate expense at each stage
compared to long-run costs spanning multiple stages with lower expenses per
stage.
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In the short run, the firm cannot modify its size of the firm. Output can be increased or decreased only by changing the variable input such as labor, and raw materials. The decision taken in the short run can be reversed.
But the long-run decision can not be reversed. Plant size can be varied.
Concept of Explicit cost
It is the firm's direct outlay of funds for things like salaries, interest, rent, raw material costs, etc. It's the real cost, the financial cost, or the accounting cost.
Short Run
To create more yield in the short run, the firm must utilize more work, which implies that it must increase its costs. We portray the way a firm’s costs alter to add up to item changes by utilizing three concepts. They are :
Total cost curve
Average cost curve
Marginal cost curve
Total cost
The total Cost of Business (TC) is the cost of all resources used. Total Fixed Cost (TFC) is the cost of a firm's fixed inputs. Fixed costs remain unchanged at the output. Total Variable Cost (TVC) is the cost of a firm's variable inputs. Variable cost varies with output.
Total Cost (TC) = TFC + TVC
In the above figure, each output stage has the same total fixed cost. As the output
increases, and the total variable cost increases. The total cost of TFC plus TVC also increases as production increases.
Average cost
The average cost measure can be derived from any of the
total cost measures. Average Variable Cost (AVC) is the total variable cost per unit of output.
Average Total Cost (ATC) is the total cost per unit of production.
ATC = AFC + AVC
ATC = TFC/Q +TVC/Q
Fixed costs don't change with changes in output. For example rent of land, the interest of capital, etc.
Variable costs change with changes in output. For example, the wage of labor, cost of raw materials, etc.
Marginal Cost
Extra cost for additional issuance or the increase in total cost due to an increase of one unit of the overall product. Marginal cost (MC) is the cost of adding one unit to production. Since fixed costs do not affect marginal costs.
Marginal cost = change in the total cost / Change in quantity(Output)
Average fixed cost decreases continuously as output increases because the total fixed cost will be distributed to more output. If a firm is producing 100 cars then the total fixed cost will be shared only with 100 cars. If the Firm produces 100000 cars then the total fixed cost will be shared with more cars. So, the graph plotted is downward sloping.
Nature of AVC
AVC curve is U shaped because as output increases the average variable cost falls to the minimum and then increases. The bottom of the U shape curve is also known as the efficient scale of production it is because the firm minimizes the cost of production at this level.
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