Firms
make use of factors of production in order to produce goods and services, each
of which has a cost (or price) attached to it, they are known as cost of production. In general
it is the expenses in terms of money for buying the raw materials, services and
other expenses to run the business (production).
Total cost is the sum total of all the costs of inputs used in the
production process. The total inputs are classified into two main categories
[fixed cost and variable cost].
Therefore
Total cost = variable
cost + fixed cost.
Fixed factors are those factors whose supply cannot be changed
easily and quickly (it is relatively a long period like building a
new factory or installation of a new machinery etc.
Variable factors are those factors whose supply can be changed easily and
quickly (it is possible in a very short period like increasing
raw materials, hand tools etc.)
Fixed cost is
a part of total cost that does not change as output changes in the short run.
Rent, wages, insurance premium, interest on loans, depreciation etc. are fixed
in nature and they do not vary with the change in production. It is also
known as indirect costs.
Depreciation is a fixed cost. The cost incurred due to the loss of value
of capital assets due to wear and tear is depreciation. The capital
assets such as machineries, motor vehicles gradually become out of
date.
Variable cost is the part of total cost that changes with the change in
output. It is also known as direct costs. The cost incurred on raw
materials, power, etc. changes when output changes.
In
Economics, marginal refers to additional and it is one of the most important
concepts. Marginal cost is the
additional cost incurred when the firm increases the output by one unit. OR
It
is the Net addition to the total cost when production increased by one unit,
and calculated using,
Marginal
Cost = Total cost of ‘n’ units – Total cost of ‘n-1’ units
Average cost is the cost per unit product. Total cost is divided by
number of units of output we get the average cost
There
is a relationship
between fixed cost, variable Cost, total Cost, marginal Cost, and
average Cost. 1) Fixed cost is fixed throughout the short
run period. 2) As output increases total cost goes on
increases. 3) Variable cost
increases along with the changes in production. 4) When
productivity increases, marginal cost and average cost
steadily declines and then steadily increases.
This
is because, when a firm expanding its output with a fixed capacity, in the
beginning firm experience increasing returns to its variable factors and later
diminishing returns. A profit maximising firm will consider the lowest point of
average cost as their Optimum point of
production
Firms
prefer to produce at the optimum point
of production. The best level is where cost of producing each good
at the lowest level possible average. At this point the entrepreneur
organize and combine the factors of production in the most cost effective or
efficient way
Back to Home Page Click here