Cost

Micro Economics
Sem I
Tip

Total Cost = Fixed Cost + Variable Cost

Basics of Cost

Fixed Cost

TipFixed Cost

Fixed Cost refers to the expenditure incurred by the producer on the use of fixed factors of production.

It is also known as supplementary cost or overhead costs. These costs are independent of output, i.e., they do not change with changes in output.

Examples of Fixed Cost

  • Contractual rent, insurance fee, maintenance costs, property taxes, interest on the capital invested etc.

We can understand this with the help of following table

Units of Output Total Fixed Cost
0 10
1 10
2 10
3 10
4 10
5 10
6 10

Variable Cost

TipVariable Cost

Variable Cost refers to the expenditure incurred by the producer on the use of variable factors of production.

It is also known as price costs or direct costs. In short run variable costs increases or decreases when the output rises or falls.

Examples of Variable Cost

  • Wages of labour employed, prices of the raw materials, fuel and power used, transportation cost etc.

We can understand variable cost with the help of following table:

Units of Output Variable Cost
0 0
1 10
2 18
3 24
4 28
5 32
6 38

Difference between Fixed Cost and Variable Costs

Difference Between Fixed Costs and Variable Costs
Fixed Costs Variable Costs
Fixed costs are the costs incurred on the fixed factors of production. Variable Costs are those costs incurred on the variable factors of production
Fixed costs do not change with increase or decrease in output. Variable costs increase with increase in output, and decrease with decrease in output
Fixed cost remains constant even when output is zero. Variable costs are zero when output is zero.
Fixed costs are incurred even before production actually starts. Variable costs are incurred only when production actually starts.

Total Cost

Total Costs is the sum of its total variable costs and total fixed cost. i.e., TC = TFC + TVC. As one component, i.e., the total variable cost (TVC) varies with the change in output, the total cost of production (TC) will also change with the changes in the level of output. The total cost increases as the level of output rises.

We can understand this with the help of following table:

Units of Output Total Fixed Cost Total Variable Cost Total Cost
0 50 0 50
1 50 20 70
2 50 35 85
3 50 60 110
4 50 100 150
5 50 145 195
6 50 190 240
7 50 237 287
8 50 284 334
Figure 1: Short-run cost curves based on the table above.
Figure 2: Representative Cost Curves to understand shape.

Marginal Cost

It is an addition to the total cost when an additional unit of output is produced. In other words, marginal cost is the addition to the total cost of producing n units instead of n – 1 units (i.e., one less) where n is any given number. Symbolically,

\[MC_n=TC_n-TC_{n-1}\] It can also be represented as: \[MC=\frac{\Delta TC}{\Delta Q}\] We can understand this with the help of following table:

Output \((Q)\) Total Cost \((TC)\) Marginal Cost \((MC)\)
0 100 -
1 125 25
2 145 20
3 160 15
4 180 20
5 206 26
6 236 30
7 273 37

Average Cost

Cost per unit of output produced is called average cost. It is also called unit cost of production.

\[AC=\frac{TC}{Q}\] Since, \[TC = TFC + TVC\] So, \[AC=\frac{TFC+TVC}{Q}\] \[AC=\frac{TFC}{Q}+\frac{TVC}{Q}\] \[AC=AFC+AVC\]

Average Fixed Cost

Average Fixed Cost is the Total Fixed Cost per unit of output. \[AFC=\frac{TFC}{Q}\] We can understand this with the help of following table:

Output Total Fixed Cost Average Fixed Cost
1 10 10
2 10 5
3 10 3.3
4 10 2.5
5 10 2
6 10 1.67
7 10 1.43
8 10 1.25

AFC cannot be zero, as it takes the shape of Rectangular Hyperbola

Average Variable Cost

Average Variable Cost is the Total Variable Cost per unit of output. \[AVC=\frac{TVC}{Q}\] We can understand this with the help of following table:

Output Total Variable Cost Average Variable Cost
1 10 10
2 18 9
3 24 8
4 28 7
5 32 6.4
6 38 6.3
7 46 6.6
8 62 7.7