TOURISM ECONOMICS

COST FUNCTION
By Ravi Ranjan
CONTENTS
COST FUNCTION DEFINITION
COST FUNCTION -TYPES
SHORT RUN COST FUNCTION
LONG RUN COST FUNCTION
WHAT IS COST FUNCTION ?
In economics, a cost curve is a graph of the costs of
production as a function of total quantity produced. In a free
market economy, productively efficient firms use these curves to
find the optimal point of production, where they make the
most profits. There are a few different types of cost curves, each
relevant to a different area of economics.
 COST OF
FUNCTION

SORT RUN LONG RUN

COST COST
FUNCTION FUNCTION
 SHORT RUN
COST
FUNCTION

AVERAGE
TOTAL COST
COST

MARGINAL
COST

TOTALFIXED TOTAL AVERAGE

VARIABLE AVERAGE VARIABLE
COST FIXED COST
COST
COST
SHORT RUN COST FUNCTION
Short-run costs are those that have a short-run implication in the process of
production. Such costs are made once that is payment of wages ,cost of raw
materials, etc. Such costs cannot be used again and again. From analytical point of
view, short-run costs are those that vary with the variation in output, the size of the
firm remaining the same . Therefore, short-run costs are treated as variable costs.

TOTAL COST FUNCTION-

According to Dooley.”Total cost of production is the sum of all
expenditure incurred in producing a volume of output”. In the short
period, total costs are composed of two costs.
TC=TFC+TCV

(Here, TC=Total cost , TFC=Total fixed cost, TVC=TOTAL VARIABLE COST)

There are two characteristic of total cost function, fixed cost &
variable cost.
Total Fixed cost-
Anatol murad says that “Fixed cost are cost which do not change with the quantity of
output.” . Production may be maximum or zero unit, fixed costs remain the same.

Quantity of Fixed cost

out put (Rs) y Fixed cost
25
0 20
1 20 20
2 20 C
3 20 15
4 20 O x
5 20 S 10
6 20 T 5
7 20 (rs) 0
8 20
o 1 2 3 4 5 6 7 8

Units of output
Here we can see that change in quantity but no change in fixed cost when output
is zero cost is Rs 20 .when output increase unit to unit fixed cost remains Rs 20.
Total variable cost
According to Dooley, “variable cost is one which varies as the level of
output varies”. These costs undergo a change with change in output .
y
Output Variable Change in 70
costs(Rs) variable
costs(^vc) 60
variable
0 0 0 50 cost(Rs.
1 10 10 )
2 40
18 8
3 30
4 24 6 change
28 4 in
5 20 variable
6 32 4
38 6 10 costs(^
7 vc)
8 46 8
0 X
62 16 0 1 2 3 4 5 6 7 8

Here we can see that variable costs rises at diminishing, constant and
increasing rate in accordance with the three stages of the law of variable
proportion.
Marginal cost
A marginal cost that graphically represents the relation between marginal cost
incurred by a firm in the short-run product of a good or service and the quantity of
output produced. This curve is constructed to capture the relation between
marginal cost and the level of output, holding other variables, like technology and
resource prices, constant. The marginal cost curve is U-shaped.

MC=TCn-TCn-1 OR MC=^TC/^Q
AVERAGE COST
Per unit cost of a on good is called its average cost. According to
Dooley , “ the average cost of production is the total cost per unit of
output .”
AC=TC/Q
Average cost

There are two characteristic of average cost function, average fixed cost &
average variable cost.
AVERAGE FIXED COST
Average fixed cost equal to total fixed cost divided by output; that is

AFC=TFC/Q
OUT FIXED AVERAG y
PUT COST E FIXED 25 AVERAGE FIXED COST
(Rs) COST average
(Rs) 20 fixed cost
1 10 10 fixed cost
2 10 5 15 AFC
3 10 3.3
4 10 2.5 10
5 10 2.0
6 10 1.7 5
7 10 1.4
8 10 1.25
0 X
1 2 3 4 5 6 7 8

Here we can see that AFC curve slopes

downward to the right.
Average variable cost
Average variable cost is total variable cost divided by output. That
is
AVC=TVC/Q
OUTPUT TOTAL AVERAGE
VARIABLE VARIABLE
COST(Rs) COST(Rs) y
1 10 10
2 18 9
3 24 8
C
4 28 7 O
5 32 6.4 S
6 38 6.3 T
7 46 6.6 (Rs)
8 62 7.8

Output x
o
output
We can see here quantity of output is show on OX-axis & cost on OY-axis. Shape of
curve is like U . It implies that average variable cost is diminishing as output is
increasing.
 LONG RUN
COST
FUNCTION

LONG RUN LONG RUN LONG RUN

TOTAL MARGINAL AVERAGE
FUNCTION COST COST
LONG RUN COST FUNCTION
Long-run cost function are those that have long-run implications in the
process of production that is they are used over a long range of output. The
cost that are incurred on the fixed factors like plant, building ,machinery ,
etc., are known as long-run costs. It is important to note that the running
cost and depreciation of the capital assets are include in the short-run cost.
There are three characteristic of
long-run cost function. that are

 Long-run total cost function

 Long-run marginal cost function
 Long-run average cost function
Long-run total cost function
According to Leibhafasky. “the long-run total cost of production (LTC) is
the least possible cost of producing any given level of output when all input
are variable.” long-run total cost is always less than or equal to short-run
total .cost, but it is never more than short-run total cost
y
LTC
STC

C
O
S
T p
(RS)

O output X
Here we can see that LTC curve represents long run total cost of different quantities
of output . Thus it is a tangent to given point on short – run total cost.
Long run marginal cost function
Long-run marginal cost refers to the change in long-run total cost , with the
production of one extra unit of commodity, when all the factors of
production are varied. According to Robert Awh, “long-run marginal cost
curve is that which shows the extra cost incurred in producing one more
unit of output when all inputs can be changed.”
Y

C LMC
O Here we can see that long-run marginal
S cost carve is also like U shape similar as
T Short-run marginal cost but this carve is
(Rs) comparatively more flatter.

O output X
Long-run average cost function
Long-run average cost is the cost of producing single unit of the
commodity, on an average, in long run period it can be calculated by
dividing long run total cost with the level of out put. According to Robert
Awh, “the LAC curve shows the lowest AC of producing output when all
inputs can be varied freely.”
Y

C LAC
Here we can see that long-run average
O
Cost carve is also like U shape similar as S
Short-run average cost but this carve T
is much flatter than short run average cost . (Rs)

O
THAN YOU