Management Time: Description of Cost-Output Relationship : Managerial Economics
TFC remains the same throughout the period and is not influenced by the level of activity. The firm will The graph below shows Short-run cost output relationship. . Only short run is explained I need both short and long. A proper understanding of the nature and behavior of costs is a must for regulation and control of cost of production. Cost –output relationship in short run 2. Cost –output relationship in long run The short run is a period which does not permit alterations in the.
During short period two types of factors are employed. One is fixed factor while others are variable factors of production. Fixed factor of production remains constant while with the increase in production, we can change variable inputs only because time is short in which all the factors cannot be varied.
Raw material, semi-finished material, unskilled labour, energy, etc. Machines, capital, infrastructure, salaries of managers and technical experts are included in fixed inputs. During short period an individual firm can change variable factors of production according to requirements of production while fixed factors of production cannot be changed.
The cost-output relation during short period can be studied with the help of short run cost curves based on short run costs as given below: Short Run Total Costs: Short run total costs of a firm are of following types: Those costs which are incurred by a firm in the production of any commodity on the basis of total fixed cost and total variable cost.
Total costs are calculated on the basis of the following formula: Short run total costs can be seen from the following table: The table reveals that total fixed cost remain constant when the production is zero or its is increasing while total variable cost is zero when production is zero and it changes with the change in output and total cost is the aggregate of total fixed cost and total variable cost. Those costs which remain constant when the output is zero as well as it is increasing are called total fixed costs.
Such costs are borne by the firm whether there is production or not.
These costs are not concerned with the production of a commodity. These costs are borne even there is zero production during short period. The Table 1 shows when production is zero the total fixed cost is Rs.
Hence, total fixed costs remain constant. These costs are also known as supplementary costs, general costs, indirect costs and overhead costs.
Those costs which vary with the production of a commodity during short period and they have direct relation with the change in production.
When production is zero these costs will be zero and when production increases they will move in the same direction. These costs are incurred on raw material, direct wages and expenses on energy or power.
Variable costs are also called prune costs or direct costs. Total variable costs show an increasing trend as shown in Diagram 1. Thus, total costs are the summation aggregates of total fixed costs and total variable costs.
All these costs are related to short run production. They are shown in the Diagram 2 on the basis of the Table 2.
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TFC is parallel to OX-axis and it remains constant whether production is zero or it is 10 units. TVC starts from zero production where it is zero and goes on increasing with the increase in output. When production is zero total cost is equal to TFC and it increases with increase in production. Average Costs or Per Unit Costs: During short period average costs or per unit costs can be divided into following categories: The average fixed cost is the total fixed cost divided by the volume of output.
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There is an inverse relation between output and average fixed cost. With the increase in output average fixed cost decreases and with the decrease in output the average fixed cost will increase.
The shape of average fixed cost curve becomes rectangular hyperbola with the increase in output. It is calculated from the following formula: The average variable cost is total variable cost divided by the volume of output. Average variable cost falls with the increase in output, reaches at its minimum and then starts rising.
By the operation of law of increasing returns the AVC decreases, and by the operation of constant returns leads to constancy in AVC and the law of diminishing returns leads to increase in AVC. The shape of AVC is U-shaped because of the operation of the laws of returns during short period. The AVC is calculated by the formula given below: The following is the formula of calculating AC: In economics theory, the short-run is defined as that period during which the physical capacity of the firm is fixed and the output can be increased only by using the existing capacity allows to bring changes in output by physical capacity of the firm.
Total cost is the actual money spent to produce a particular quantity of output. But the Total Variable Cost i.
Cost Output Relation: Long and Short Run | Microeconomics
Average cost is the total cost per unit. It can be found out as follows. Marginal Cost is the addition to the total cost due to the production of an additional unit of product. It can be arrived at by dividing the change in total cost by the change in total output. In the short-run there will not be any change in Total Fixed C0st.
Cost Output Relation: Long and Short Run | Microeconomics
Hence change in total cost implies change in Total Variable Cost only. The table is prepared on the basis of the law of diminishing marginal returns. The fixed cost Rs. The table shows that fixed cost is same at all levels of output but the average fixed cost, i.
The expenditure on the variable factors TVC is at different rate. If more and more units are produced with a given physical capacity the AVC will fall initially, as per the table declining up to 3 rd unit, and being constant up to 4th unit and then rising.
But the rise in AC is felt only after the start rising. Thus the table shows an increasing returns or diminishing cost in the first stage and diminishing returns or diminishing cost in the second stage and followed by diminishing returns or increasing cost in the third stage. The short-run cost-output relationship can be shown graphically as follows.
But AVC curve i. If the rise in variable cost is less than the decline in fixed cost, ATC will still continue to decline otherwise AC begins to rise. Cost-output Relationship in the Long-Run Long run is a period, during which all inputs are variable including the one, which are fixes in the short-run.
In the long run a firm can change its output according to its demand. Over a long period, the size of the plant can be changed, unwanted buildings can be sold staff can be increased or reduced. The long run enables the firms to expand and scale of their operation by bringing or purchasing larger quantities of all the inputs. Thus in the long run all factors become variable. The long-run cost-output relations therefore imply the relationship between the total cost and the total output.
In the long-run cost-output relationship is influenced by the law of returns to scale. In the long run a firm has a number of alternatives in regards to the scale of operations.
For each scale of production or plant size, the firm has an appropriate short-run average cost curves. The short-run average cost SAC curve applies to only one plant whereas the long-run average cost LAC curve takes in to consideration many plants. It does not mean that the OQ production is not possible with small plant.
Rather it implies that cost of production will be more with small plant compared to the medium plant. It is also known as planning curve as it serves as guide to the entrepreneur in his planning to expand the production in future. Description of Cost-Output Relationship: Managerial Economics Cost-output relationship plays an important role in determining the optimum level of production.
Simple Thoughts: COST OUTPUT RELATIONSHIP IN THE SHORT RUN
Knowledge of thecost-output relation helps the manager in cost control, profit prediction, pricing, promotion etc. Proper understanding of the nature and behavior of costs is a must for regulation and control of cost of production.
Cost-output Relationship in Long-Run — This is a period, during which all inputs are variable including the one, which are fixes in the short-run. Long-run cost-output relations therefore imply the relationship between the total cost and the total output. Inputs like land and buildings, plant and machinery etc. It means that short-run is a period not sufficient enough to expand the quantity of fixed inputs.
TFC remains the same throughout the period and is not influenced by the level of activity. The firm will continue to incur these costs even if the firm is temporarily shut down. Even though TFC remains the same fixed cost per unit varies with changes in the level of output.
On the other hand TVC increases with increase in the level of activity, and decreases with decrease in the level of activity.
If the firm is shut down, there are no variable costs. Even though TVC is variable, variable cost per unit is constant.
The graph below shows Short-run cost output relationship.