Cost

Short-Run Cost Functions

Total Cost = TC = f(Q)

Total Fixed Cost = TFC

Total Variable Cost = TVC

TC = TFC + TVC

Short-Run Cost Functions

Average Total Cost = ATC = TC/Q

Average Fixed Cost = AFC = TFC/Q

Average Variable Cost = AVC = TVC/Q

ATC = AFC + AVC

Marginal Cost = TC/Q = TVC/Q

Short-Run Cost Functions

Q TFC TVC TC AFC AVC ATC MC0 $60 $0 $60 - - - -1 60 20 80 $60 $20 $80 $202 60 30 90 30 15 45 103 60 45 105 20 15 35 154 60 80 140 15 20 35 355 60 135 195 12 27 39 55

Long-Run Cost Curves

The Long-run Average Cost (LAC) curve is the cost curve showing the average cost of production at different levels of output, turned out by different sized plants.

Long-Run Cost Curves

Long-Run Total Cost = LTC = f(Q)

Long-Run Average Cost = LAC = LTC/Q

Long-Run Marginal Cost = LMC = LTC/Q

Relationship Between Long-Run and Short-Run Average Cost Curves

LAC When the firm produces the

Q1 level of output, it uses the plant 1 such that it incurs Q1C average costs.

As and when the firm has to produce Q2, it builds another plant such that the average cost involved is Q2C2 rather than Q2C*1

Similarly, to produce Q3,the firm will employ plant 3 so that it can save costs C3C*2.

Thus, the LAC will turn out to be an envelope curve, i.e., it is tangential to different short run cost curves appropriate to different sized plants

Economies and Diseconomies of Scale

Internal Economies and Diseconomies When a firm expands in size by increasing the scale of its

output, certain cost advantages accrue to the firm, those are called internal economies.

External Economies and Diseconomies of Scale

The external economies occur when there are physical and cost advantages that result from the general development of the industry. When the industry expands, it offers scope for specialisation and skill formation and for lateral and vertical integration.

Internalised External Economies However, when railway line (external) is available due to public

investment, a firm may undertake private investment to construct its own feeder line to get better advantage of public rail line

Externalised Internal Diseconomies Many chemical plants produce a lot of pollutants (i.e., internal

diseconomies) and then discharge the same in either water or air (i.e., externalisation).