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PHBM

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IMPLICIT COST

• Value of input services that are used in production but not purchased in a market

• Example : self-owned factory

EXPLICIT COST

• Value of resources purchased for production

• Example : wages and salaries, expenditure for machinery

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Cost in The Short Run

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Fixed Cost

• Cost of inputs that are independent of output

• No relationship with output.

• TFC remains constant throughout the production period

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Variable Cost

• Cost of input that changes with output

• Incurred on the purchase of variable inputs

• Output = 0, TVC = 0

• TVC changes in response to changes in output

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Total Cost

• Sum of fixed and variable costs

• TC = TFC + TVC

• TC will not start from zero

• TC will change in the same proportion as TVC

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Average Cost@Average Total Cost

U-shaped

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Average Fixed Cost

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Average Variable Cost

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Marginal Cost

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TC, TVC, TFC ATC, AFC, AVC, MC

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Relationship Between Productivity Curve & Cost Curve

Relationship between MP and MC

• MP is rising and then falls, MC is falling and then rises.

Relationship between AP and AVC

• AP rising to the max and then declines, AVC is falling to the minimum and then increases.

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Relationship Between AVC and MC

• MC > AVC; AVC ↑

• MC < AVC; AVC ↓

• MC = AVC; AVC min

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Long Run Production Cost

Long Run Average Cost (LRAC) curve is a curve that shows the minimum cost of producing any given output,

when all the inputs are variable.

Derived from a series of short run average cost

(SRAC)

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A

B

C

Q1 Q2

1) Firm has a plant

relating to

SRAC1, total

output Q1.

2) The demand increases and the firm wants to increase its output from Q1 to Q2, the firm can still operate on the same plant SRAC1 but the ATC will increase from point A to B.

3) If the firm expanding the output as in SRAC2, the output of Q2 can be

produced at a lower average cost at point C. SRAC3 , SRAC4 and SRAC5 refer to plants of a higher capacity

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LRAC curve is U-shaped due to the LAW OF RETURNS TO SCALE. As the firm expends in

size, its LRAC will decrease and increase at a later stage.

Benefits or advantages a firm enjoys as it grows

larger

Problems or disadvantages

faced by a firm as it grows larger

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ECONOMIES AND DISECONOMIES OF SCALE

ECONOMIES OF SCALE

Internal ExternalLabor Government

Managerial Concentration

Marketing Information

Technical Marketing

Financial

Risk-bearing

Transportation and Storage

Economies which arise

from the actions of an individual

firm (happen inside an

organization)

advantages of an industry as a whole

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ECONOMIES AND DISECONOMIES OF SCALE

DISECONOMIES OF SCALE

Internal ExternalLabor Scarcity of raw material

Management Wage differentials

Technical Concentration problemsEconomies which arise

from the actions of an individual

firm (happen inside an

organization) Disadvantages of an industry as a

whole

Q&A