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COST OUTPUT RELATIONS IN SHORT RUN

Short Run Costs: The level of output in any industry depends on two factors. i) The number of firms in the industry and ii) The size of firms or the scale of then operation. The short period is that one, which is long enough to permit any desiced change of output altering the scale of output.

Fixed costs:
The costs incurred on factors of production which are fixed in the shortrun. Ex: Cost of running fixed equipment, salaries of administration staff, depreciation of machinery etc., These are the costs incurred even at zero output. These costs remain fixed in the short-run only.

SHORT RUN & LONG RUN COSTS


The distinction between short run and long run does

not relate to calender period of time. It relates to the


conditions of production. Short run is period during which

all factors are not variable.

1. Average Fixed Cost (AFC): It is a rectangular


hyperbola. 2. Average Variable Cost (AVC): The total variable cost of a firm varies with output in the short-run. The average variable cost decreases in the first stage and later increases the average variable cost curve is Ushaped.

Total variable cost TVC AVC = --------------------------- = ------output O

Average Total Cost (ATC):


Average total cost unit is the total cost (FC + VC) divided by the number of units produced. The average total

cost will therefore be greater than average variable cost


and average fixed cost. The short-run average cost curve

tends to be U-shaped. Total Cost ATC = -------------Output

TC = -----O

TFC + TVC ATC = AFC + AVC = -----------------Output

Average Total Cost (ATC):


Average total cost unit is the total cost (FC + VC) divided by the number of units produced. The average total

cost will therefore be greater than average variable cost


and average fixed cost. The short-run average cost curve

tends to be U-shaped. Total Cost ATC = -------------Output

TC = -----O

TFC + TVC ATC = AFC + AVC = -----------------Output

Elements of Short Run Cots:


Output units Fixed costs AFC (2/1) Variable costs AVC TC Average total cost Short run marginal cost

5 (4/1) 6 (2+4)

7 (6/1)

1.
2. 3. 4. 5.

20
20 20 20 20

20
10 6.6 5.0 4.0

10
18 24 30 40

10
9.0 8.0 7.5 8.0

30
38 44 50 60

30
19 14.6 12.5 12.0

-8.0 6.0 6.0 10.0

6.
7. 8.

20
20 20

3.6
2.85 2.50

54
70 88

9.0
10.0 11.0

74
90 108

12.3
12.8 13.5

14.0
16.0 18.0

Marginal cost: It is the addition to the total cost caused by producing one more unit. It is the increment in aggregate costs when output is increased by one unit; or the reduction in cost which follows the reduction of output by one unit. It is the difference between total cost of N units and total cost of N-1 units. TC Marginal cost = ------Q Change in Total cost = ----------------------------Change in Output

Importance of Distribution Between Fixed & Variable costs Adjustment of Output:


1. Decision to shut down the firms. 2. Break Even point. 3. Project.

Long Run Marginal Cost:


The long-run marginal cost curve cuts the long-run
average cost curve at its concert point if will be flatter than the short run marginal cost curve. If output is increased, marginal costs rise more sharply in the short run than in the long run and vice-versa.

Relation Between AC & MC:It is very important in price theory. Both AC & MC are calculated from the total cost.
Output (units ) Total Cost (Rs.) Average Cost (Rs.) Marginal Cost (Rs.)

1 2 3 4 5 6 7 8

10 18 24 28 35 48 63 80

10 9 8 7 7 8 9 10

-8 6 4 7 13 25 17

Total cost AC = -----------------Total output Change in total cost TC MC = ------------------------------- MC = -------Change in output Q i) When AC is falling, MC also declines but MC < AC. MC

reaches a minimum and then begins to increase even


though AC is falling. ii) When AC is minimum, MC cuts it from below. iii) When AC is rusing, MC lies above AC and rises faster than AC.

Assumptions :1. The total cost can be divided into fixed and variable costs.

2. The behaviour of fixed and variable costs remain fixed.


3. Price is constant as volume of output changes. 4. Sales mix is constant. 5. Management policies do not change as production expends.

6. Production sales cycle is co-responsive to the phases


of expansion and contraction. 7. Efficiency level remains the same.

Usefulness of BEA:1. It provides a micro scope view of the profit structure of the firm which will help the firm in planning profit.

2. Helpful fore cost control.


3. It provides a flexible set of projections of revenue and costs under expected future conditions. 4. It can be used for determining safety margins regarding extent to which the firm can permit decline in sales

without causing losses. Sales BEP Safety margin --------------------- x 100 Sales

5. It is useful in determining target profit sale volume. TFC Target Profit Target Sales Volume = --------------------------Contribution margin

Limitations:
1. Difficult to apportion all costs (whether fixed or variable) 2. Selling price does not remain constant sales do not change in direct proportion to output.

4. Some variable costs may decline i.e., assumption that


variable costs change proportionately with output is not valid. 5. Difficult to apportion fixed costs to each product separately (increase of multi products sale) 6. Its scope is limited to short period only. 7. Difficult to handle selling costs. They influence sales.

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