Professional Documents
Culture Documents
Production
Dr. C S Shylajan
Topics to be Discussed
WHAT?
Relationship between Production and
Costs
Measuring Cost: Which Costs Matter?
Cost in the Short Run
Cost in the Long Run
Topics to be Discussed
Short-Run Cost Curves
Long-Run Cost Curves
Plant Size and Economies of Scale
Plant Size and Diseconomies of Scale
Economies of Scope
Breakeven Analysis
Estimating and Predicting Costs
Why Cost Analysis is important?
Costs play in determining the profitability of the
firm
Conventional accounting statements do not
always present the information needed for
effective managerial decisions
Understand various cost concepts
Understand concepts of economies of scale and
scope and apply them to business strategy
Introduction
TC = FC + VC
Measuring Cost:
Which Costs Matter?
Fixed
Fixed and
and Variable
Variable Costs
Costs
Fixed Cost
Does not vary with the level of output
Cost paid by a firm that is in business regardless of
the level of output
Fixed cost must be paid even if output is zero
Variable Cost
Cost that varies as output varies
Example?
A Firm’s Short-Run Costs
Rate of Fixed Variable Total Marginal Average Average Average
Output Cost Cost Cost Cost Fixed Variable Total
(FC) (VC) (TC) (MC) Cost Cost Cost
(AFC) (AVC) (AC)
AFC= TFC/Q
Average Variable Cost is Total Variable Cost
divided by the quantity of output produced
AVC= TVC/Q
Cost in the Short Run
TFC TVC
ATC = +
Q Q
Cost in the Short Run
That is,
TC
ATC = AFC + AVC or
Q
Cost in the Short Run
0 1 2 3 4 5 6 7 8 9 10 11 12 13 Output
Cost Curves for a Firm
Cost
(Rs per
100
unit)
MC
75
50 AC
AVC
25
AFC
0 1 2 3 4 5 6 7 8 9 10 11 Output (units/yr.)
Cost in the Long Run
E
2000
D
1000
Output, Units/yr
100 200 300
Long-Run Cost Curves and Returns to
Scale
In the long-run:
Cost
(Rs per unit
of output LMC
LAC
Output
Economies of Scale
Percentage change in Q
Measuring Economies of Scale
∆ Q (LTC2 + LTC1)
Observations
There
is no direct relationship
between economies of scope and
economies of scale.
May experience economies of
scope and diseconomies of scale
May have economies of scale and
not have economies of scope
Economies of Scope
CQ1 =$2000
CQ2 =$3000
C (Q1, Q2) = $4000
SC= ($2000+$3000 ) – ($4000)
$4000
=$1000/$4000 =0.25
Approx..25 % saving in cost due to joint
production.
Economies of Scope
Interpretation:
Qb = TFC/ (P-AVC)
TFC = Total Fixed Cost
P= Price of product
AVC= Average Variable Cost
Break-even Analysis
Suppose a firm producing a product
which has total fixed cost per month
$100000, Average Variable Cost of
production is $20, Selling Price of
Product is $30. What is the breakeven
output ?
BE output=TFC/ (P- AVC)
100000/ (30–20)
= 10,000 units. Why don’t you calculate
total sales revenue at breakeven point?
Summary