Costs

Short-run costs

Total cost
 Output TFC
Total costs for firm X
100 (Q) (Rs.)

0 12
1 12
80 2 12
3 12
4 12
60 5 12
6 12
7 12
40

20

0
0 1 2 3 4 5 6 7 8
 Output TFC
Total costs for firm X
100 (Q) (Rs.)

0 12
1 12
80 2 12
3 12
4 12
60 5 12
6 12
7 12
40

20
TFC
0
0 1 2 3 4 5 6 7 8
 Output TFC TVC
Total costs for firm X
100 (Q) (Rs.) (Rs.)

0 12 0
1 12 10
80 2 12 16
3 12 21
4 12 28
60 5 12 40
6 12 60
7 12 91
40

20
TFC
0
0 1 2 3 4 5 6 7 8
 Output TFC TVC
Total costs for firm X
100 (Q) (Rs.) (Rs.)

0 12 0 TVC
1 12 10
80 2 12 16
3 12 21
4 12 28
60 5 12 40
6 12 60
7 12 91
40

20
TFC
0
0 1 2 3 4 5 6 7 8
 Total costs for firm X
100

TVC
80

Diminishing marginal
60
returns set in here

40

20
TFC
0
0 1 2 3 4 5 6 7 8
 Output TFC TVC
Total costs for firm X
100 (Q) (Rs.) (Rs.)

0 12 0 TVC
1 12 10
80 2 12 16
3 12 21
4 12 28
60 5 12 40
6 12 60
7 12 91
40

20
TFC
0
0 1 2 3 4 5 6 7 8
 Output TFC TVC TC
Total costs for firm X
100 (Q) (Rs.) (Rs.) (Rs.)

0 12 0 12 TVC
1 12 10 22
80 2 12 16 28
3 12 21 33
4 12 28 40
60 5 12 40 52
6 12 60 72
7 12 91 103
40

20
TFC
0
0 1 2 3 4 5 6 7 8
 Output TFC TVC TC
Total costs for firm X
100 (Q) (Rs.) (Rs.) (Rs.) TC
0 12 0 12 TVC
1 12 10 22
80 2 12 16 28
3 12 21 33
4 12 28 40
60 5 12 40 52
6 12 60 72
7 12 91 103
40

20
TFC
0
0 1 2 3 4 5 6 7 8
 Total costs for firm X
100 TC
TVC
80

Diminishing marginal
60
returns set in here

40

20
TFC
0
0 1 2 3 4 5 6 7 8
 Short-run costs

Marginal cost = TC / Q
Costs (Rs.) Deriving marginal costs
120
Q TC MC
100 0 12
10
1 22
6
2 28
80 5
3 33
7
4 40
12
60 5 52
20
6 72
31
40
7 103

20

0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Deriving marginal costs
120
Q TC MC
100 0 12 TC
10
1 22
6
2 28
80 5
3 33
7
4 40
12
60 5 52
20
6 72
31
40
7 103

20

0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Deriving marginal costs
120
Q TC MC
100 0 12 TC
10
1 22
6
2 28
80 5
3 33
7
4 40
12
60 5 52
20
6 72
31 TC = 12
40
7 103
Q = 1
20

0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Deriving marginal costs
120
Q TC MC
100 0 12 TC
10
1 22
6
2 28
80 5
3 33
7
4 40
12
60 5 52
20
6 72
31
40
7 103
Diminishing
returns set
MC
in here
20

0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Deriving marginal costs
35
MC
30

25
Diminishing marginal
20 returns set in here

15

10

0
0 1 2 3 4 5 6 7
Q
 Short-run costs

Average cost
=TC / Q
Costs (Rs.)
35

30

25

20

15

10

0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Q TVC AVC
35 0 0 -
1 10 10
30 2 16 8
3 21 7
25 4 28 7
5 40 8
20 6 60 10
7 91 13
15

10

5
AFC
0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Q TVC AVC
35 0 0 -
1 10 10
30 2 16 8
3 21 7
25 4 28 7
5 40 8
20 6 60 10
3 13
7 91
15

10 AVC

5
AFC
0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Q TC AC
35 0 12
1 22 22
30 2 28 14
3 33 11
25 4 40 10
5 52 10.4
20 6 72 12
7 103 14.7
15

10 AVC

5
AFC
0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Q TC AC
35 0 12
1 22 22
30 2 28 14
3 33 11
25 4 40 10
5 52 10.4
20 6 72 12
7 103 14.7
15
AC

10 AVC

5
AFC
0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Q TC MC
35 0 12
10
1 22
6
30 2 28
5
3 33
7
25 4 40
12
5 52
20
20 6 72
31
7 103
15

10

0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Q TC MC
35 0 12
10 MC
1 22
6
30 2 28
5
3 33
7
25 4 40
12
5 52
20
20 6 72
31
7 103
15

10

0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Q TC MC AC
35 0 12 -
10 MC
1 22 22
6
30 2 28 14
5
3 33 11
7
25 4 40 10
12
5 52 10.4
20
20 6 72 12
31
7 103 14.7
15

10

0
0 1 2 3 4 5 6 7
Q
Costs (Rs.) Q TC MC AC
35 0 12 -
10 MC
1 22 22
6
30 2 28 14
5
3 33 11
7
25 4 40 10
12
5 52 10.4
20
20 6 72 12
31
7 103 14.7
15
AC

10

0
0 1 2 3 4 5 6 7
Q
 Average and marginal costs
MC
AC

AVC
Costs (Rs.)

x
AFC

Output (Q)
 Long-run costs

Long-run costs
=TC / Q
 Alternative long-run average cost curves

Economies of Scale
Costs

LRAC

O Output
 Alternative long-run average cost curves

LRAC
Diseconomies of Scale
Costs

O Output
 Alternative long-run average cost curves

Constant costs
Costs

LRAC

O Output
 A typical long-run average cost curve

LRAC
Costs

O Output
 A typical long-run average cost curve

Economies Constant Diseconomies LRAC

of scale costs of scale
Costs

O Output
 Long-run average and marginal costs

Economies of Scale
Costs

LRAC
LRMC

O Output
 Long-run average and marginal costs

LRMC

LRAC
Diseconomies of Scale
Costs

O Output
 Long-run average and marginal costs

Constant costs
Costs

LRAC = LRMC

O Output
 Long-run average and marginal costs

LRMC
Initial economies of scale,
then diseconomies of scale
LRAC
Costs

O Output
 Long-run costs

Relationship between
short-run and long-run
AC curves
Deriving long-run average cost curves: factories of fixed size

SRAC1 SRAC SRAC5

2
SRAC4
SRAC3

5 factories
Costs

1 factory
2 factories
3 factories4 factories

O
Output
Deriving long-run average cost curves: factories of fixed size

SRAC1 SRAC SRAC5

2
SRAC4
SRAC3

LRAC
Costs

O
Output
Deriving long-run average cost curves: choice of factory size
Costs

Examples of short-run
average cost curves

O
Output
 Deriving long-run average cost curves: choice of factory size

LRAC
Costs

O
Output
 Explicit and Implicit Costs

Explicit Costs : The money payment

that a firm makes to the outsiders
who supply inputs.
These are the “out of pocket ” costs.
Eg. Salaries, price paid for raw
material, components etc.
Implicit Costs : The costs of the “self
owned” resources which are
employed by the firm and are non –
expenditure costs.
Eg. Salary of the proprietor, interest
on the entrepreneur’s own
investment etc.
Economic Profit versus Accounting Profit

Economists measure a firm’s

economic profit as total revenue
minus all the opportunity costs
(explicit and implicit).
Accountants measure the
accounting profit as the firm’s total
revenue minus only the firm’s
explicit costs. In other words, they
ignore the implicit costs.
 Economic Profit versus
Accounting Profit
When total revenue exceeds both
explicit and implicit costs, the
firm earns economic profit.
Economic profit is smaller than
accounting profit.
 Economic Profit versus Accounting Profit

How an Economist How an Accountant

Views a Firm Views a Firm

Economic
profit
Accounting
profit
Implicit
Revenue costs
Revenue
Total
opportunity
costs
Explicit Explicit
costs costs