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Thursday, 12 May 2011

Relationship between the various costs

Cost of Production or Total Cost :-
The total sum of money required for the production of specific quantity is called the cost of production.

Following elements are included in the total cost . (1) Rent of land (2) Wages (3) Interest (4) Normal profit (5) Wear tear (6) Taxes (7) Insurance charges etc.

Explicit Cost :-
It paid to the workers out side the business, the payment is made to those people who supply raw material and labour services.

Implicit Cost :-
Implicit costs are not paid to the out sides. For example, if a person is working as a manager in his own firm the reward of his services will be included in the expenses. Implicit costs are alternative costs of the self employed resources of the firm.

Nominal Cost :-
The payments which are made to the four factors of production in order to set up the process of production is called nominal cost.

Real cost or Opportunity cost :-
Lipsey says, "The opportunity cost of using any factor is what is currently foregone by using it."
In other words to detain any factor of production in the present occupation the cost should be equal to the amount which he can get in same alternative occupations. For example a man is working in factory and getting Rs. 1000/- monthly. The entrepreneur is paying this amount because a worker can earn Rs. 1000/- in other factory. If he pays less than this amount, the worker will move to next occupation. So a real cost ( Rs.1000 ) detains him in this occupation.

Fixed Cost :-
It is that cost which does not change with the changes in out put per period of time. Such cost has to be incurred even the product is zero. Rent, interest and salary of permanent staff is included in it.

Variable Cost :-
In varies with volume of product directly. If the production increases the variable cost also increases. Cost of raw material and wages, are the examples of variable cost.

Average Cost :-
Average cost is obtained by dividing the total cost by total number of commodities produced.

ATC = Total cost / Q or ATC = AVC + AFC

Marginal Cost :-
Marginal cost means the additional cost of producing one more unit of out put. For example the cost of production one Cap is Rs.100 and the total cost of producing two Caps is Rs. 190. Then marginal cost will be 190 - 100 = 90. MC = 90

Relationship between the Costs :-
We can explain the relationship between the costs by the following table.

Explanation :- As regards the relation of costs, total costs increases with the increase in production but not according the same ratio. But variable cost increases in the same proportion with the production. While fixed Cost remains the same.
Average cost decreases with an in crease in production in the beginning but as the firm achieves the full capacity, then it begins to increase.
We can also explain these concepts by the diagram.

Fixed Cost :- In this diagram total fixed cost of a firm is assumed Rs.20 at various levels of out put, so MN curve moves parallel.

Total variable cost :- In this diagram the total cost curve increases with the higher level of out put.

The marginal cost curve decreases sharply with smaller out put and reaches to minimum . As production increases, it begins to rise.


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