economics for managers - session 08

8/3/2019 Economics For Managers - Session 08

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PSG INSTITUTE OF MANAGEMENTMBA 2011-13 BATCH

I TRIMESTER

SESSION VIII - FOR BATCH C AND DCOST FUNCTION

ECONOMICS FOR

MANAGERS


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Cost of Production

12/09/11EFM Faculty P.Uday Shankar

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Cost of production is the cost of the factors used. Factors of production have to be paid or rewarded for their use.

Note that Normal Profit is viewed as a Cost. ( Accountants could be puzzled

!!). Any profit earned in excess of the profit needed to reward theentrepreneur is called Excess Profit.

The reward to the entrepreneur is in other words the Opportunity Cost of

keeping the entrepreneur from going elsewhere.

Factor of Production Cost

Land Rent

Labour Wages

Capital Interest

Enterprise Normal profit


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Fixed and Variable Costs


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In the short run certain costs are fixed as availability ofresources is restricted. Such costs are Fixed Costs.Eg. A factory pays Rs 25,000 as fixed cost towards the cost of a machineleased-in by it for say two years regardless of how many units of outputare produced using the machine. Even if the factory shuts downproduction for a month due to any reason it must pay the amount Rs25,000 for the period. Other egs. are rent for the premises.

Payments for Variable inputs are called Variable Costs.

Eg. Payments for certain types of labour, raw materials..

The behaviour of the costs are studied under a ShortRun and a Long Run time period.


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Short Run Total Costs

In the short run the levels of use of certain inputs are fixed and thecost related to these have to be paid regardless of the level of theoutput. Other costs vary over time.

Total Fixed Cost: TFC is the sum of the shortrun fixed costs that must be paid regardlessof the level of the output produced.

Total Variable Cost: TVC is the sum of theamounts spent for each of the variable

inputs used. Total Cost: TC: Short run TC, which also

increases as output increases, is the sum oftotal fixed cost and total variable cost.


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Short Run Total Cost Schedule

1 2 3 4

Output (Q) Total Fixed CostTFC) Rs

Total VariableCost (TVC) Rs

Total Cost (TC)=TFC+TVC-Rs

0 6000 0 6000

100 6000 4000 10000

200 6000 6000 12000

300 6000 9000 15000

400 6000 14000 20000

500 6000 22000 28000

600 6000 34000 40000


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Total Cost Curves


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0

5000

10000

15000

20000

25000

30000

35000

40000

45000

1 2 3 4 5 6

Total Fixed Cost TFC) Rs

Total Variable Cost (TVC) Rs

Total Cost (TC)=


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Average and Marginal Costs

1 2 3 4 5

Output (Q) Average FixedCost(AFC)=TFC/Q

AverageVariableCost (AVC)

AVC=TVC/Q

AverageTotal Cost(ATC)=TC/Q

Short RunMarginalCost (SMC)SMC=TC/

Q0 - - -

100 60 40 100 40

200 30 30 60 20

300 20 30 50 30

400 15 35 50 50

500 12 44 56 80

600 10 56.7 66.7 120


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Average and Marginal Cost Curves


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0

20

40

60

80

100

120

140

1 2 3 4 5 6

AVC

ATC

SMC


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Short Run Marginal Cost

Short Run Marginal Cost (SMC) is the changein either total variable cost or total cost perunit change in output.

SMC= TVC = TCQ Q

It can be seen that MC first declines and reaches a minimum of Rs20 and then rises. Note that MC is attained at an output between 100and 200 below of what AVC and ATC attain their minimums.

Marginal cost equals AVC and ATC at their respective minimumlevels.


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Looking back

Qd = f(P,M,PR, T,Pe,N) Demand Curve

Demand Curve Shift

Qs =g(P,Pi,Pr,T,Pe,F)

Supply Curve

Supply Curve shift

Market Equilbrium

Q= f(X1,X2,X3,.., Xn)

Q=f(L,K)

Q= f(L,) Production Function marginal product

(MP will equal AP when AP is at its maximum)

Short Run Marginal Cost.


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Short run production and short run costs

SHORT RUNPRODUCTION

SHORT RUN TOTAL COSTS

Labour (L) Output (Q) TotalVariable

Cost (TVC)

TVC= wL(1000xL)

Total FixedCost (TFC)

TFC= rK

Total Cost(TC)

TC= wL+rK

0 0 0 6000 6000

4 100 4000 6000 10000

6 200 6000 6000 12000

9 300 9000 6000 15000

14 400 14000 6000 20000

22 500 22000 6000 28000

34 600 34000 6000 40000


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Average and Marginal relations between Cost and Production

Short run production Short run cost

Labour(L)

Output(Q)

AP = Q/L MP=Q/L

AVC SMC

0 0 - - - -

4 100 25 25 40 40

6 200 33.33 50 30 20

9 300 33.33 33.33 30 30

14 400 28.57 20 35 50

22 500 22.73 12.5 44 80

34 600 17.65 8.33 56.67 120


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Production and Cost in the Long Run

Q=f(L,K)

Isoquant: An isoquant is a curve (or locus ofpoints) showing all possible combinations of

the inputs physically capable of producing agiven (fixed) level of output. ( Pic Pg 346).

Isocost Curve: An isocost curve allcombinations of inputs that may be purchased

for a given level of total expenditure at giveninput prices. ( Pic Pg 350)


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05/09/2011EFM Faculty P.Uday Shankar 14

Units oflabour(L)

Units of Capital (K)

0 1 2 3 4 5 6 7 8 9 10

0 0 0 0 0 0 0 0 0 0 0 0

1 0 25 52 74 90 100 108 114 118 120 121

2 0 55 112 162 198 224 242 252 258 262 264

3 0 83 170 247 303 342 369 384 394 400 403

4 0 108 220 325 400 453 488 511 527 535 540

5 0 125 258 390 478 543 590 631 653 663 670

6 0 137 286 425 523 598 655 704 732 744 753

7 0 141 304 453 559 643 708 766 800 814 825

8 0 143 314 474 587 679 753 818 857 873 885

9 0 141 318 488 609 708 789 861 905 922 935

10 0 137 314 492 617 722 809 887 935 953 967


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Thanks


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economics for managers - session 08

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