Production is the result of effective combination of factors of production. The factors should have to be paid and are paid by the firm for the combination of their services. land is paid rent, labour is paid wage ,capital is paid interest. Thus the concept of cost refers to all expenses incurred by the firm on the production of commodity or services.
Explicit cost:-It refers to actual payments made by a firm for the purchase of goods from other firms and hiring of the services of production. Examples of explicit costs are payments of raw materials, wages to hired workers etc.
Implicit cost:-It refers to the imputed costs of the factors of production owned by the producer himself, which are generally left out in the calculation of the expenses of the firm. Examples are: rent of his own land, interest on his own capital, salary for his own services as manager etc.
Fixed and variable costs:-costs of production are divided into fixed costs and variable costs. Fixed costs remain fixed whatever be the volume of output. They have to be incurred by the firm whether there is production or not. They include rent of factory buildings, interest on loan, salaries for permanent to workers, insurance etc. They are otherwise called supplementary costs or indirect cost or overhead costs.
Variable costs, on the other hand, vary with output. Costs of raw materials used in the production, wages to casual labours etc. come under this category. These costs will increase when output increases because for a large output more raw materials, more labours etc are needed. It disappears completely when output is zero.
Total cost is the sum total of the fixed cost and variable cost. As the total cost fixed cost remains constant, it is the change in variable cost that brings about a change in total cost. It increases with an expansion of output and decrease when the output falls. However, when output is zero the total cost of a firm is equal to its total fixed. The following table and diagram explains the relation between total fixed cost, total variable cost and total cost.
|Units of out put||TFC||TVC||TC|
Average cost or average total cost
Average cost is the cost per unit.
AC= TC ÷ No. of units
Average variable cost:- average variable cost is the variable cost per unit of output.
AVC=TVC÷ No of units
Average fixed cost:- average fixed cost is the fixed cost per unit of output.
AFC= TFC÷ No of units
Therefore average cost is sum total of average variable cost and average fixed cost.
Marginal cost is the addition to total cost by the production of an additional unit of output.
Revenue:-revenue is the money receipts from the sale of the product.
Total revenue:-Total revenue is the total amount of money realized by the firm from the sale of its products.
Average revenue:-average revenue is the revenue per unit of output sold.
AR=TR÷ No of units
Marginal revenue:-Marginal revenue is the addition to the total revenue by sale of an additional unit of output.
- TC=TFC +TVC
- TAC or AC = TC ÷ No. of units
- AVC=TVC÷ No of units
- AFC= TFC÷ No of units
- AC=AFC +AVC
- AR=TR÷ No of units
Profit is the one of the main motives of production in a market economy. It is calculated as the difference between revenues and costs. Profits might fall because of a decrease in firm’s revenues of an increase in the firm’s production costs or a combination of both.
Cost, labour and machines
A firm may replace with labour with machines this might be led to higher level of output with lover cost of production. The fixed cost of production is likely to rise because of machines are fixed assets. If labour has been paid salaries, irrespective to the level of output, then the replacement of labour with machines will reduce fixed costs. However, it is more likely that factory workers are paid wages piece-rate, relative to the level of output produced. Therefore, it is likely that replacing labour with machines will reduce the variable costs of production. The effect on total cost of production will depend on the relative changes in the fixed and variable costs of production
The breakeven point:- The break even –point is the point at which total revenues equal total costs.
The following diagram shows break even point