COST COMPUTATION

Presented By: Karl Brian M. Joble

What is Cost?

• Anything incurred during the production of the good or service to get the output into the hands of the customer.

• An amount paid or required in payment for a purchase.

Note• Controlling costs is essential to Business Success.• It is important to point out that production

involves cost.

Cost Theory• Offers an approach to understanding the

costs of production that allows firms to determine the level of output that reaps the greatest level of profit at the least cost. – E-How.com

– Contains various measures of costs. These include a firm's fixed costs and variable costs.

• Aside from Monetary and Economic Resources also have Opportunity Cost. Opportunity cost is the opportunities forgone in the choice of one expenditure over others. – Answers.com

Cost Concept: Economic Costs• Private vs. Social CostPrivate – Are expenses shouldered by individual producers. Ex. Rent

and Cost of MaterialSocial – Additional Cost are involved that are not paid by the

producers but are Bourne by the society. Ex. Cement for Highways

• Explicit vs. Implicit CostExplicit – consist of actual payments made by the firms for resources

bought or hiredImplicit – Cost of Self owned or Self employed resources.

• Total Fixed vs. Total Variable Cost – Short-runFixed – Resources whose quantity cannot be readily be changed for

short run. (Salaries, Rent, Insurance, Maintenance)Variable – Can be readily changed when output is increased in short

run. (Wages of Laborers, Cost of Raw Materials and Transportation)

Short-run Cost ScheduleQty Fixed

Cost (FC) Variable Cost

(VC) Total CostTC=FC+VC

Marginal Cost MC =^TC /^Q

Average Fixed CostAFC=FC/Q

Average Variable

Cost AVC=VC/Q

Average Cost

AC=TC/Q

0 50 0 50 - - -

1 50 25 75 25 50 25 75

2 50 45 95 20 25 22.5 47.5

3 50 75 125 30 16.67 25 41.67

4 50 120 170 45 12.50 30 42.5

5 50 175 225 60 10 35 45

6 50 250 300 75 8.33 41.67 50

7 50 340 390 90 7.14 48.57 55.71

• Marginal costs(MC) – The cost of producing an extra unit of output. MC = Change in TC / Change in Q

• Total Cost (TC) – Composed of total Fixed Cost and Total variable Cost. TC = FC + VC

• Average Fixed Cost (AFC) – Decreases continuously as output increases. The Greater Output the Smaller the AFC. Due to fixed cost that is spread to more output levels. AFC = FC/Q

• Average Variable Cost (AVC) – Refers to the variable costs per unit of output produced by the firms.

AVC = VC/Q

• Average Cost (AC) – Obtained by Dividing TC by Level of Output, it also obtained by adding the sum of AFC and AVC. AC = TC/Q or AC = AFC + AVC

SUMMARY• Economic costs are incurred in producing

output. These Cost can be private or social, explicit or implicit, fixed or variable.

• In the short-run, firms pays both fixed and variable costs. Thus, total cost is the sum of total fixed cost and total variable cost.

• Fixed costs are part of the total cost and do not depend on output. Variable cost are dependent on the output.

• When AC and AVC are falling, MC is below them. When AC and AVC are rising, MC is above them.

• MC and AC intersect at the minimum point of AC. MC and AVC intersect at the minimum point of AVC.

• The average FC keeps falling as output is increased

• As output rises, the share of FC in average costs becomes smaller and negligible

REFERENCE:

• Macarubbo, Josefina (2005) “Basic Economics”. Quezon City Phil: New Horizon Publication.

• Sicat, Gerardo. Costs, Supply, and the Firm. Economics.