Cost is related to production. A producer needs land, labor, capital, and organization to produce output. Cost is payable to these factors of production in terms of rent, wage, interest, and profit. In other words, the cost is the aggregate of all search monetary expenses incurred by the producer in the course of the production of goods and services.

cost in finance


Short-run cost and long-run cost

There is no fixed time that can be marked to separate the short run from the long run. The short-run and long-run districts depend on the time needed for adjustment in plant firms and various from one industry to another.

Short-run cost

Short-run is a period during which the physical capacity of the firm remains fixed. It is a period of time in which the quantity of at least one input is fixed and the quantities of the Other inputs can be varied. Any increase in output during this period is possible only by using the physical capacity more extensively. So short run is that which varies with the output when the plant and capital equipment are held constant.

Long-run cost:

The long run is a period of time in which the quantities of all inputs can be buried and hence, all costs are variable in the long run. As a firm can make adjustments to all factors, in the long run, all inputs are variable, and there are no fixed costs. Long-run cost at those, which vary with the output when all input is variable including plant and capital equipment.

Concept of short-run costs

Short-run cost is that which varies with the output when the plant and capital equipment are held constant in the short run. The total, average, and marginal cost in the short run as shown below;

1. Total fixed cost (TFC)

TFC refers to total money expense incurred on fixed inputs like a plant, Machinery, tools, and equipment, etc In the short run. It is independent of output. It must be paid even if the frame produces no output. It is independent of output and remains fixed whether the output is large or small. Fixed costs are also called 'overhead costs', 'sunk costs', or 'supplementary costs'.

Total fixed cost comprises the following;

1. Salaries of Administrative staff and other administrative expenses.

2. Charges such as contractual, insurance fee, license fee, property tax, interest on the borrowed fund.

3. Depreciation of machinery.

4. Expense of buildings depreciation and repairs.

5. Expense for land maintenance and depreciation (if any).

The table shows the total fees cost remaining constant at 50 at all levels of output. The TFC call curve in the figure is horizontal and parallel to the x-axis, including that it is constant regardless of output.

2. Total variable cost (TVC):

TVC refers to money expense incurred on the variable factor inputs like raw materials, power, fuel, water, transport, and communication, etc. employed to buy a firm in the short run. Total variable cost corresponds to variable input employed in the short run.

TVC is an increasing function of output. In other words, TVC varies with the output. It may be expressed symbol equally as:

TVC =  f (Q)

Here, Q donates output; f and function.

The total variable cost is incurred only when production takes place. When a firm halts production in the short run, the total variable cost will be zero. TVC sharply in the beginning, gradually in the middle, and at the end in accordance with the law of variable proportion.

TVC curve slopes upwards from left to right. TVC curve rises as output is expanded. When the output is zero, TVC is also zero. hence, the TVC curve starts from the origin. Start from the origin.

Total variable cost includes the following:

a. Expenses on labor force employed.

b. Expenses on raw material, fuel, and power

c. Transportation expenses.

d. Expenses of fixed capital equipment.

e. Marketing and publicity expenses.

The TVC curve has an inverse S shape, which reflects the law of variable proportions. Initially, due to increasing returns, the TVC curve is concave downwards, eventually, it becomes convex downwards due to decreasing returns.It implies that initially, the total variable cost (TVC) increasing at a decreasing rate, and at later stages, it increases at an increasing rate.

3. Total cost TC

It is the cost of produce given units of output. It refers to the aggregated money expenditure incurred by a firm to produce a given quantity of output.

Symbolically, the TC may be expressed as:

TC is = f(Q)

Here, Q donates output; and f denotes function.

It means that the TC varies with the output . For example, the total cost to produce 20 units of output at the rate of Rs.10 per unit is Rs. 200 [20*10= Rs.200]. Similarly, total cost to produce 20 units of output at the rate of Rs 25 per unit is Rs 500.

Total cost includes fixed as well as a variable costs. Hence, TC= TFC+ TVC. TC varies in the same proportion as TVC. In other words, a variation in TC is the result of variation in TVC since TFC is always constant in the short run.

The total cost curve Rises upwards from left to right. In our example, the TC curve starts from Rs 50 because even if there is no output, TFC is a positive amount. TC and TVC have the same shape because an increase in output increases them both by the same output since TFC is constant. TC curve is derived binding of vertically the TVC and TFC curves. The vertical distance between the TVC curve and TC curve is equal to TFC and is constant throughout out because TFC is constant.

4. Average fixed cost( AVC)

Average this cost is the fixed cost per unit of output. When TFC is / total units of output AFC is obtained, Thus,

Average fixed cost = total fixed cost/total output

AFC= TSC/Q

Since AFC is falling continuously as output increases; the AFC curve also Falls continuously from left to right end or negative slope.

AFC curve approaches both Axes, that is, it gets very near to but never touches either of the axes. AFC will never become zero because the TFC is a positive amount.

5. Average variable cost (AVC)

The average variable cost is the variable cost per unit of output. It is the ratio of the variable cost of output.

Symbolically,

Average variable cost= total variable cost /total output

AVC=TVC/Q

Where, TVC= total variable cost,Q= output 

The AVC curve falls initially, reaches a minimum, and then Rises as output increases. It falls slowly as the firm output rises from zero to the normal capacity level . Once the normal capacity output is reached AVC curve rises sharply with the increase in output. As such, the AVC curve is of U- shape.

6. Average Cost (AC)

The average cost is per unit of cost of output. In other words, the average cost is the ratio between total cost and total output.

Average cost= total cost/total output

AC= TC/Q

For example; suppose rs500 is required to produce 50 units of output. Here total cost (TC)= Rs 500, output (Q)=50

AC=TC/Q

= Rs 500/50 = Rs 20

Also,AC is the sum of an AFC and AVC.i.e AC =AFC +AVC

In the short run, the AC curve also tends to be U-shaped. The combined influence of AFC and AVC curves shapes the nature of the AC curve. Initially, AC falls due to increasing returns and eventually Rises due to decreasing returns.

The short-run AC curve is also called the "plant curve". Indicates the optimum utilization of a given plant for optimum plant capacity.

7. Marginal cost (MC);

The marginal cost will be defined as the net addition to the total cost as one more unit of output is produced. It is expressed as the change in total cost.

Symbolically,

MCn = TCn-TC n-1.

Where,

             MCn = MC of nth unit.

             TCn = TC of current output.

             TC n-1 = TC of previous output.

Marginal cost is also defined as the additional cost of producing an additional unit of output. In other words marginal cost is the ratio between the change in total cost and change in total output.

Marginal cost = change in total cost/chang in output 

MC = ΔTC / ΔQ

Where, deltaTC = change in the total cost and ΔQ = change in quantity

MC is independent of TFC, and it is directly related to TVC. In the short run, the MC curve also tends to be U-shaped.

The shape of the MC curve is determined by the law of variable proportions. If MC is falling production will be under the conditions of increasing returns and if  MC is rising, production will be subject to diminishing returns.

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