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Short-Run Cost

The document discusses several concepts related to cost analysis: 1) It defines relevant costs as those affected by management decisions, while sunk costs cannot be recovered and should not influence future decisions. 2) Fixed costs remain constant regardless of production level, while variable costs change with output. Total costs are the sum of fixed and variable costs. 3) Marginal cost is the change in total cost from producing an additional unit of output and typically rises due to diminishing returns. 4) Average costs are calculated by total costs divided by units of output and include average fixed cost, average variable cost, and average total cost.

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Linh Pham
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50 views

Short-Run Cost

The document discusses several concepts related to cost analysis: 1) It defines relevant costs as those affected by management decisions, while sunk costs cannot be recovered and should not influence future decisions. 2) Fixed costs remain constant regardless of production level, while variable costs change with output. Total costs are the sum of fixed and variable costs. 3) Marginal cost is the change in total cost from producing an additional unit of output and typically rises due to diminishing returns. 4) Average costs are calculated by total costs divided by units of output and include average fixed cost, average variable cost, and average total cost.

Uploaded by

Linh Pham
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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COST

ANALYSIS

Presentation
TABLE OF CONTENT

Relevant cost Short-Run Relationship

Between Production and Cost

Sunk cost

Marginal cost The Short-Run Cost Function


RELEVANT COST

Presentation
RELEVANT COST

A cost is relevant if it is affected by a


management decision. A cost is irrelevant if it is
not.
Relevant
cost In deciding among different courses of action, the
manager needs only consider the differential
revenues and costs of the alternatives.
RELEVANT COST

Opportunity
Economic costs Accounting costs

measure the cost in money, measure the monetary value


Costs time, and other resources of of taking an action. They are
taking an action. They are both the explicit costs.
associated with
the explicit and implicit costs.
choosing a particular

decision is measured
Economic profit Accounting profit
by the benefits forgone
is the difference between is the difference between
in the next-best
revenues and all economic revenues obtained and
alternative. costs (explicit and implicit), expenses incurred.

including opportunity costs.
EXAMPLE
A firm owns its own building and pays Forgone rent ($10000) is the opportunity cost of
no rent for office space. This means using the building for doing business
the cost of office space is zero
Accounting cost = Operating expense = $50000
Business revenue is $100000,
Accounting profit = Revenue - Accounting cost
operating expense is $50000
= $50000
If the firm does not do business, the
building could have been rented for Economic cost = Operating expense + Forgone rent
$10000 =$60000
Economic profit = Revenue - Economic cost

=$40000
SUNK COST

Expenditure that has been made and cannot be

recovered
SUNK

COST Should not influence a firm's future economic

decisions
EXAMPLE
The company is planning to expand
The cost already incurred for the market

its business and is considering


research is a sunk cost
launching a new product.

The company spends $10000 for

market research to determine the


The cost cannot be recovered and should

profitability of the new product. not be taken into consideration while

deciding on whether the company should

The study concludes that the new


launch the product or not.
product will not be profitable and

may even be unsuccessful.


SHORT-RUN

RELATIONSHIP BETWEEN

PRODUCTION AND COST

Presentation
Short-Run Relationship

Between Production and Cost

A firm’s cost structure is intimately related


to its production process.

The firm’s cost is found by totaling its


expenditures on labor, capital, materials,
and any other inputs and including any
relevant opportunity costs.
Short-Run Relationship

Between Production and Cost

Fixed costs result from the firm’s expenditures on


fixed inputs. These costs are incurred regardless of
the firm’s level of output.
Ex: the cost of equipment ,factory ,tax...
Total cost is

the sum of

fixed cost and


Variable costs represent the firm’s expenditures on
variable cost. variable inputs.

Ex: the cost of labor

Short-Run Relationship

Between Production and Cost

In order to illustrate the


relationship, consider the
production process
described in the table.

According to the table, the repair firm’s With respect to the short-run operations of the

total fixed costs come to $270,000 per repair firm, labor is the sole variable input.
year. These costs are incurred Variable costs represent the additional wages

regardless of the actual level of output paid by the firm for extra hours of labor. To

(i.e., even if no output were produced). achieve additional output, the firm must incur

additional variable costs.


THE SHORT-RUN
COST FUNCTION

Presentation
THE SHORT-RUN
COST FUNCTION

Average total cost (ATC) is the


average per unit cost of using all of the TC TFC + TVC
ATC = = = AFC + AVC
firm’s inputs, which is the total cost Q Q
divided by the total quantity of output
THE SHORT-RUN
COST FUNCTION

Average variable cost (AVC) is the


average per-unit cost of using the TVC
firm’s variable inputs, which is variable
AVC =
cost divided by total output
Q
THE SHORT-RUN
COST FUNCTION

Average fixed cost (AFC) is the


average per-unit cost of using the TFC
firm’s fixed inputs, which is fixed cost
AFC =
divided by total output
Q
MARGINAL COST

Presentation
MARGINAL COST

MC =
∆TC Marginal cost is the addition to
total cost that results from
Q increasing output by one unit.
The table consists of a firm’s
MARGINAL COST total cost, average cost and
marginal cost and annual output.

The last column of the


table above lists the repair
company’s marginal costs
for output increments of
5,000 units.
MARGINAL
COST
Consider an output increase from
25,000 to 30,000 units

The result is a total cost increase of


1,440,000 - 1,207,500 = $232,500

The marginal cost (on a per unit basis):


232,500/5,000 = $46.50/unit.
With labor the only variable input,
MARGINAL COST short-run marginal cost (SMC)
can be expressed as:

∆C ∆C/∆L
Suppose the prevailing wage is $20 per
PL
SMC =
∆Q ∆Q/∆L MPL
= = hour and labor’s marginal product is .5
unit per hour (one-half of a typical repair
job is completed in one hour)
PL: The price of hiring additional
labor (i.e., wage per hour)

MPL: the marginal product of


labor Then the firm’s marginal (labor) cost:
20/.5 = $40 per additional completed job
MARGINAL COST The law of diminishing returns

With other inputs fixed, adding increased amounts of a variable


input (in this case, labor) generates smaller amounts of
additional output; that is, after a point, labor’s marginal product
declines. As a result, marginal cost rises with the level of output.
The marginal cost line intersects
the average cost and average
MARGINAL COST variable cost at their minimum
value points.

At point M, it is the intersect


between MC and AC graphs, it
is called break-even point.

At point N, it is the intersect


between MC and AVC graphs,
it is called shutdown point
THANK YOU

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