COST

FUNCTION
COST FUNCTION IN SHORT
RUN

• Cost function may be defined as the

relationship between costs of a
product and output.

C = F [Q]
 SHORT
RUN COST

COST
LONG
RUN COST
 SHORT RUN COST
FUNCTION

• An analysis in which certain

factors are assumed to be fixed
during the period analyzed.

• In short run output can be

increased or decreased by changing
only the variable factors.
 Fixed cost

+
Short Variable cost
run cost

=
Total cost
SHORT RUN FIXED COST

• Fixed cost are those cost which do not

change with changes in output.

• Fixed cost are otherwise called

‘supplementary cost’ or ‘over head costs’.

Eg ; Rent on land and building , Insurance

charges, Interest on fixed capital, Salary
of permanent employees.
SHORT RUN VARIABLE COST

• Variable cost are those costs which

changes with changes in output.

• Variable cost are also called ‘prime

cost’.

Eg; cost of raw materials, cost of power

in production, wages of workers.
 SHORT RUN TOTAL COST

• Total cost is defined as the Total actual cost

that must be incurred to produce a given
quantity of output.

• Fixed cost and variable cost are formally called

Total fixed cost and Total Variable cost.

TC = TFC + TVC
UNITS OF OUTPUT TFC TVC TC
[Rs.] [Rs.] [Rs.]

0 60 60 -60 = 0 60

1 60 100 -60 = 40 100

2 60 120 – 60 = 60 120

3 60 70 130

4 60 100 160

5 60 160 220

6 60 300 360
SHORT RUN TOTAL COST
CURVE
.............

TFC being fixed at Rs.60, remains the same at

all levels of output . Thus, the TFC- curve is a
straight line parallel to the x-axis.

TVC – curve starts from the origin at zero

output . It move upwards from left to right.

The shape of TC –curve is the same as TVC-

curve.
SHORT RUN AVERAGE
COST
AVERAGE FIXED
COST
SHORT
RUN
AVERAGE AVERAGE
VARIABLE COST
COST

AVERAGE
FIXED COST
AVERAGE FIXED COSTS
• AFC is the per unit fixed cost of
producing a commodity. It is
obtained by dividing the total fixed
cost by the quantity of output [Q].

AFC = TFC

Q
AVERAGE VARIABLE COST

• AVC is the per unit variable cost of

producing a commodity . It is
obtained by dividing the total
variable cost by the quantity of
output.
AVC = TVC

Q
 AVERAGE TOTAL COST

• AC is the sum total of AFC and AVC.

AC = TC

Q
 SHORT RUN AVERAGE
MARGINAL COST CURVE

• MARGINAL COST ; Marginal cost is

the addition to total cost by the
production of an additional unit of
output.

MCn = TCn - TCn-1

;w
Units of TFC TVC TC AFC AVC ATC MC
productio [Rs] [Rs] [Rs] [Rs] [Rs] [Rs] [Rs]
n
O 60 0 60 - - - -

1 60 40 10 60 40 100 40

2 60 60 120 30 30 60 20

3 60 70 130 20 23.3 43.3 10

4 60 100 160 15 25 40 30

5 60 160 220 12 32 44 60

6 60 300 360 10 50 60 140

SHORT RUN AVERAGE
MARGINAL CURVES
• The short –run MC curve will at first
decline and the ATC and AVC at their
minimum points.

• The AVC curve will go down , and then

go up.

• AFC curve will decline as additional

units are produced , and continue to
decline.

• ATC curve initially will decline as the

fixed cost are spread over a large
number of units , but will go up as MC
increase due to the law of diminishing
returns.
Break even analysis
The BEP is defined as a no-profit or no-loss point.
Why is it necessary to determine the BEP when
there is neither profit nor loss? It is important
because it denotes the minimum volume of
production to be undertaken to avoid losses
. In
other words, it denotes the minimum volume of
production to be undertaken to avoid losses. In other
words, it points out how much minimum is to be
produced to see the profits. It is a technique for profit
planning and control, and therefore is considered a
valuable managerial tool.
Break – even analysis is defined as analysis of costs
and their possible impact on revenues and volume of
the firm. Hence, it is also called the cost-volume –
profit analysis. But there is slight difference between
the two. CVP analysis is broader and it includes the
entire planning for profit, while Break Even Analysis
is a technique used in this process. But we used these
two terms as interchangeable words. A firm is said to
attain the (BEP) when its total revenue is equal to
total cost (TR = TC)
Assumptions Underlying Break-even Analysis:
The following are the assumptions underlying break-even
analysis:
a) Costs can be classified into fixed and variable costs.
b) Total fixed cost remains constant at all levels of output
c) Variable cost is varies on the basis of output
d) Selling price does not change with volume changes. It remains
fixed. It does not consider the price discounts or cash
discounts.
e) All the goods produced are sold. There is no closing stock.
f) There is only one product available for sale.
g) In case of multi-product firms, the product mix does not
change.
Significance of BEA:
Break-even analysis is a valuable tool
 To ascertain the profit on a particular level of sales volume or a given capacity of
production
 To calculate sales required to earn a particular desired level of profit
 To compare the product lines, sales area,, methods of sale for individual company
 To compare the efficiency of the different firms
 To decide whether to add a particular product to the existing product line or drop one
from it
 To decide to ‘make or buy’ a given component or spare part
 To decide what promotion mix will yield optimum sales
 To assess the impact of changes in fixed cost, variable cost or selling price on BEP
and profits during a given period
Limitations of Break-Even Analysis:
Break-even analysis has certain underlying assumptions which form its limitations
 Break-even point is based on fixed cost, variable cost and total revenue. A change
in one variable is going to affect the BEP.
 All costs cannot be classified into fixed and variable cost. We have semi-variable
costs also. Incase of multi-product firm, a single chart cannot be of any use. Series
of charts have to be made use of.
 In case of multi-product firm, a single chart cannot be of any use. Series of charts
have to be made use of.
 This analysis is useful in short run not in long run.
 Total cost and total revenue lines are not always straight as shown in the figure.
The quantity and price discounts are the usual phenomena affecting the total
revenue line.
 Where the business conditions are volatile. BEP cannot give stable results.