Question

What is cost of production? Explain with suitable example.

Answer 1

Total Fixed and Variable Costs can be shown as average and marginal costs also. In the following table 1.1 all cost measurements have been shows for different levels of output which also shows their interrelationship.

 

                                                  Table 1.1

                                       (Various Cost Relationships)      

 

Quantity of Output	FC	VC	TC	AFC	AVC	AC	MC
0	50	-	50	-	-	-	-
1	50	10	60	50.0	10.0	60.0	10
2	50	19	69	25.0	9.5	34.5	9
3	50	27	77	16.7	9.0	25.7	8
4	50	34	84	12.5	8.5	21.0	7
5	50	42	92	10.0	8.4	18.4	8
6	50	52	102	8.3	8.7	17.0	10
7	50	64	114	7.1	9.1	16.2	12
8	50	78	128	6.3	9.8	16.1	14
9	50	96	146	5.6	10.7	16.3	18
10	50	120	170	5.0	12.0	17.0	24

 

       In the above table we find that the fixed cost (FC) is constant but variable cost (VC) is increasing with every increase in output. The increase in this cost is equal to marginal cost (MC). For example, the variable cost of 5 units is $42 and the MC of 6th unit is $10. Hence the variable cost of units is 42 + 10 = $52. In column 4, fixed and variable costs have been added to give total cost (TC). Column 5 shows average fixed cost (AFC), which has been found by dividing FC (Column 2) by the quantity produced (Column-1). Average variable cost (AVC) has been shown in column 6, which we find by dividing VC (Column-3) by the quantity (Column-1) The average cost (AC)(Column-7) has been found by adding AFC and AVC or by dividing TC by quantity. Marginal cost (Column 8) shows an increase in total cost due to one unit increase in quantity.

       When we analyse this table we find that MC first decreases but after a point starts increasing. AFC continuously goes down. AVC also falls in the beginning but rises thereafter. Because of these changes AC first falls steeply, then reaches its minimum level and then gradually starts rising. Students are advised to clearly understand these changes as it would help them understand the nature of cost curves shown hereafter.

      The changes taking place in the various costs are not random but follow a pattern as per laws of returns. The returns and costs have inverse relationship. Decrease in marginal cost is on account of increasing returns and increase in marginal cost is due to diminishing returns. That is why we first see decrease in MC and increase thereafter. MC in turn affects VC and AC.

In the following table 1.1 all cost measurements have been shows for different levels of output which also shows their interrelationship.

Cost inccured on production process of product is production cost.