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CHAPTER
COST OF PRODUCTION
COST CONCEPTS
IMPLICIT COST
Value of input services that are used in
production but not purchased in a market.
EXPLICIT COST
Value of resources purchased for production.
COST
CONCEPTS
OPPORTUNITY COST
The value of a resource in its next best use.
SOCIAL COST
Total cost of production of a good that
includes direct and indirect costs.
SUNK COST
The cost that a firm cannot recover from
the expenditure it has made.
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
COST OF PRODUCTION
SHORT RUN
TC = TFC + TVC
TOTAL FIXED COST (TFC)
The cost of inputs that are
independent of output.
Examples: Factory, machinery and
etc.
ATC =
TC
Q
TC = TVC + TFC
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
TC
TVC
TC = TVC + TFC
TOTAL VARIABLE COST (TVC)
The cost of inputs that changes with output.
TFC
TOTAL FIXED COST (TFC)
The cost of inputs that is independent of output.
QUANTITY
COST
MC
ATC
AVC
AVERAGE VARIABLE COST (AVC)
Total variable cost (TVC) divided by total output
AVC = TVC
Q
AFC
QUANTITY
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
Total costs
(1)
Quantity
(Q)
(2)
Total
fixed
cost
(TFC)
(3)
Total
variable
cost
(TVC)
Average costs
(4)
Total
cost
(TC)
TC=TFC
+TVC
(5)
Average
fixed cost
(AFC)
AFC =
TFC/Q
(6)
Average
variable
cost (AVC)
AVC =
TVC/Q
(7)
Average
total cost
(ATC)
ATC =
TC/Q
(8)
Marginal
cost (MC)
(2)+(3)
(2)/(1)
(3)/ (1)
(4)/(1) or
(5)+(6)
(4) /(1)
MC =
TC/Q
20
20
20
15
35
20
15
35
15
20
25
45
10
12.50
22.50
10
20
30
50
6.67
10
16.67
20
35
55
8.75
13.75
20
45
65
13
10
STAGE II
STAGE III
STAGE I
SATC
SAVC
STAGE II
AFC continuous to decline and SATC will become minimum.
ATC remains constant at this stage since the falling effect of
AFC and rising effect of AVC is balanced.
.
STAGE III
The falling effect of AFC is lower than rising effect of AVC,
therefore ATC begins to increase.
SAFC
QUANITTY
ATC curve is U-Shaped because of the combined influences of AFC and AVC
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
Quantity
ATC falling, MC curve lies below ATC curve.
ATC is at minimum point, ATC curve and MC curve are equal.
ATC starts to increase, MC curve lies above ATC curve.
RELATIONSHIP BETWEEN
PRODUCTIVITY AND COST
Production
MP
AP
Labour
Cost
MC
AVC
Quantity
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
ISOCOST
An isocost line shows various combinations of two inputs,
TC = wL + rk
Where:
TC = Total Cost
L = Labour
K = Capital (fixed)
w = Price of labour
r = Price of capital
ISOCOST (cont.)
Isocost Line
6
Capital
5
4
3
Isocost
2
1
0
1
Labour
Isocost line shows the various combinations of labour and capital with
given total cost for a firm in the production of shoes.
ISOCOST MAP
An isocost map is a number of isocost lines that
show different levels of total cost in one diagram.
Isocost Map
7
6
Capital
4
Isocost (RM100)
3
Isocost (RM120)
2
1
0
1
7 Labour
All Rights Reserved
Ch. 6: 16
Capital
7
6
5
4
3
2
1
0
Isocost (RM100)
Isocost (RM120)
Isoquant
y
z
Labour
Points x and z are not efficient because the cost of production is exceeding RM120.
average cost.
SRAC5
SRAC2
SRAC4
LRAC
SRAC3
LRAC
Increasing
Return to
Scale
Constant
Return to
Scale
Decreasing
Return to
Scale
Quantity
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
larger.
Reduce long run average cost (LRAC).
Marketing economies, financial economies, labour
economies, technical economies, managerial economics.
DISECONOMIES OF SCALE
Problems faced by a firm as it becomes larger and larger.
Decrease long run average cost (LRAC).
Mismanagement, competition, labour diseconomies.
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
ECONOMIES OF SCALE
Economies of scale are benefits and advantages of a firm
as it expands its production.
Reduce the average cost.
INTERNAL
Internal economies happen inside an
organization
EXTERNAL
Advantages of the industry as a whole
Labour Economies
Managerial Economies
Marketing Economies
Economies of Concentration
Technical Economies
Financial Economies
Economies of Information
Economies of Marketing
EXTERNAL
Labour Diseconomies
Management Problem
Technical Difficulties
Concentration Problem
23
Ch. 6: 23
CONCEPT OF REVENUE
TOTAL REVENUE (TR)
The total amount received from the sale of a firms goods and services
Total Revenue (TR) = Price (P) x Quantity (Q)
PxQ
= PRICE
MR = TR/ Q
(1)
Quantity
(2)
Price
(3)
Total Revenue
(1) x (2)
(4)
Average
Revenue
(5)
Marginal Revenue
(3) / (1)
(3) / (1)
10
20
30
40
50
60
70
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
50
45
40
35
30
25
20
500
900
1200
1400
1500
1500
1400
50
45
40
35
30
25
20
50
40
30
20
10
0
-10
All Rights Reserved
Ch. 6: 26
Price
Total
Revenue
(TR)
Average
Revenue
(AR)
Marginal Revenue
(MR)
10
10
10
10
10
20
10
10
10
30
10
10
10
40
10
10
10
50
10
10
Quantity
Price
AP, MP
15
10
5
0
AR=MR=DD
10
20
30
40
50
All Rights Reserved
Ch. 6: 27
Price
Total
Revenue (TR)
Average
Revenue
(AR)
Marginal Revenue
(MR)
10
10
10
10
18
24
28
30
AP, MP
Price
15
10
5
0
AR=DD
MR Quantity
10
20
30
40
50
All Rights Reserved
Ch. 6: 28