Thursday, September 26, 2013

Cost Curves in Microeconomics

Concepts of Cost

The concept of cost is very important in micro economics because it is used to find out total revenue, total cost determines the amount of profit. Therefore a firm always tries to minimize its cost. In order to produce goods, a firm uses materials and factors of production (land, labour, capital etc.) called - inputs. The expenditure incurred on these inputs is called - cost of production.

In economics, the term 'cost' is used in a variety of way such as:
  • Money cost
  • Real cost
  • Opportunity cost
  • Explicit cost
  • Implicit cost
  • Private cost
  • Social cost
  • Accounting cost and
  • Economic cost

Short - run and Long - run Cost

When economists examine firms over time they must define the short-run and long-run.
  1. Short run:
    • Only some input (e.g. labour) can be adjusted
    • Not enough time to adjust all input ( such as Capital(K))
  2. Long run:
    • Long enough time to adjust all input (K as well as Labout(L))

Short - run Total Cost

In short - run, some factors of production are fixed while some are variable. Accordingly, the costs of production of the firm in the short - run are divided into fixed costs and variable costs.

1. Total Fixed Costs (TFC)
  • Total costs of fixed factors are known as Total Fixed Costs.
  • These costs don't vary with the change in volume of output.
  • Whether the output is zero or maximum, fixed costs remain the same.
  • These costs are also known as supplementary costs or indirect costs.
  • Total fixed costs include costs like as rent, wages of permanent employees, interest on fixed capital, insurance charges and property tax.
2. Total Variable Cost (TVC)
  • Total variable costs are cost of variable factors.
  • When output changes these costs also change.
  • As the output increases, these cost also increase and vice-versa.
  • When output is zero, these costs are also zero.
  • These costs are also called Prime cost or Direct cost.
  • Total variable costs include expenses like as purchases of raw materials, wages of casual labour, expenses on electricity etc.
3. Total Cost (TC)
  • Total costs are the total expenses incurred by a firm in producing a given quantity of a commodity.
  • Total costs consist of total fixed costs (TFC) and total variable costs (TVC).
  • Hence, TC = TFC + TVC

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