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Short run total costs

Short run is a period of time in which at least one input is fixed and the output can be increased or decreased by changing only the amount of variable factors. A firm cannot change its plant, equipment and scale of organization. In this period, certain factors can be easily adjusted to increase / decrease the level of output. E.g. - If a firm wants to expand its production, it can purchase more raw materials.

Total Fixed Cost (TFC)

As we have already studied, fixed costs do not vary with the output. These costs are also called as sunk costs. The total fixed cost curve is shown as a straight line parallel to the X-axis, indicating that, whatever may be the level of production, the fixed cost remains constant. E.g. - Expenses incurred on fixed inputs like plant, machinery and tools, etc.
 
Description: 21779.png

Total Variable Cost (TVC)

Variable costs refer to those costs which vary with the output. The total variable cost curve is inverse S-shaped and starts from the origin which shows that if production is stopped, variable costs are not incurred. As the production increases, the total variable cost also increases. Initially, as more of the variable factor is combined with the fixed factor, total productivity increases at an increasing rate, and total variable cost increases at a diminishing rate. But after this point, as more of the variable factor is combined with the fixed factor, variable cost increases at an increasing rate. E.g. - Expenses incurred on variable inputs like labour, raw materials, power and fuel, etc.
 
Description: 21783.png
 
There are two types of variable costs:
  • Semi Variable Cost: There are some costs which are neither perfectly variable nor absolutely fixed in relation to the changes in the size of output. These are known as semi-variable costs. For example- Electricity charges include both a fixed charge and a charge based on consumption as shown in the diagram.
Description: 21786.png
  • Stair-Step Variable Cost: Some cost remain fixed over certain range of output, but suddenly jump to a new higher level when output goes beyond given limit. For example-Salary of a foreman remains fixed and every one extra that the foreman works, overtime should be paid. Let it be 100/- per hour. In this case the variable cost jumps a new higher level of output, as shown in the following diagram.
Description: 22189.png

Total Cost (TC)

It is the total amount of money spent by the manufacturer to produce a given level of output. Thus, it is the sum total of total fixed cost and total variable cost.
 
Symbolically,
 
TC = TFC + TVC
TC = Cost per unit x Number of units manufactured
 
Description: 21796.png
Short run average costs

Average Fixed Cost (AFC)

It refers to the total fixed cost spent by the manufacturer to produce one unit of output. It is obtained by dividing the total fixed cost by the number of units of the commodity produced.
 
AFC = TFC/Q, where Q is the number of units produced
 
Since total fixed costs are constant, the average fixed cost curve diminishes with the output. Thus, the average fixed cost curve is a rectangular hyperbola. Graphically,
 
Description: 21800.png

Average Variable Cost (AVC)

It refers to the total variable cost incurred by the manufacturer to produce one unit of output. It is the total variable cost divided by the number of units of output produced.
 
AVC = TVC/Q, where Q is the number of units produced
 
Average variable cost curve is U-shaped. As the output increases, the AVC will fall up to the normal capacity of output due to the operation of increasing returns. But, beyond the normal capacity of output, the AVC will rise due to the operation of diminishing returns. Graphically, it can be represented as follows:
 
Description: 21805.png

Average Total Cost (ATC)

It is the sum of the average variable cost and average fixed cost. It is also known as the unit cost. Symbolically,
 
ATC = AFC + AVC or ATC = TC/Q
 
The ATC curve will always be U-shaped because of the operation of the law of returns to scale. Graphically,
 
Description: 22239.png

Marginal Cost (MC)

It is the addition made to the total cost by the production of an additional unit of output.
 
Example: If it costs 500 to produce 10 units of a commodity and 550 to produce 11 units of commodity, then MC would be 50 (i.e. 550 – 500).
 
MC is obtained by calculating the change in TC as a result of a change in the total output. Thus, MC is the rate at which TC changes with output. Hence,
 
MC = ∆TC/ ∆TQ
 
The MC curve is U-shaped. The shape of the cost curve is determined by the law of variable proportions. If increasing returns (economies of scale) is in operation, the marginal cost curve will decline, as the cost decreases with the increase in output. While the diminishing return (diseconomies of scale) is in operation, the MC curve will increase as it is a situation of increasing cost.
 
MC = TCn – TCn-1
 
Description: 21821.png
 
Now, let us see the behaviour of all of the above cost curves.
 
Description: 22255.png
 
We notice that, in the beginning, both, AVC and AFC curves fall. Therefore, the ATC curve also falls sharply. When the AVC curve begins to rise, AFC curve still falls steeply, the ATC curve continues to fall. This is because; the fall in AFC curve is greater than the rise in AVC. But as output increases further, there is a sharp rise in AVC which offsets the fall in AFC. Therefore, ATC curve first falls, reaches it’s minimum and then rises. The ATC curve changes because of MC. Thus, the MC curve passes through the minimum of the average cost curve.
 
Let us now discuss the cost concepts in the form of a table.
 
Units of
Output
Total
Fixed
Cost
Total
Variable
Cost
Total
Cost
Average
Fixed
Cost
Average
Variable
Cost
Average
Cost
Marginal
Cost 
0
1,500
0
1,500
-
-
-
-
20
1,500
200
1,700
75.00
10.00
85.00
10.00
50
1,500
500
2,000
30.00
10.00
40.00
10.00
100
1,500
900
2,400
15.00
9.00
24.00
8.00
200
1,500
1,500
3,000
7.5
7.5
15.00
6.00
500
1,500
6,500
8,000
3.00
13.00
16.00
16.67
1,000
1,500
15,000
16,500
1.5
15.00
16.50
17.00

 

Note:

  • Fixed costs do not change with output. Therefore, the average variable cost comes down
  • Variable cost increases, but not in the same proportion as the increase in output
  • Marginal cost declines gradually and then increases Relationship between




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