COST ANALYSIS

By Prof R.Ballabh
09234678019 ballabhraman@ymail.com

COST ANALYSIS
In managerial economics, demand estimation & forecasting of demand are very essential in decision making. Other ,very essentials in decision making, are the cost of production. Total cost and total revenue determines the profit level. Management needs cost in terms with resource period, rate of change with respect with output &degree of their controllability

Cost concept
Future cost matters most in managerial decision making If the environment in which the firm operates does not change ,such present /future cost are not considered in decision making. Cost of production provides the floor to price. Help to accept order, whether to abandon an old /establish a new product/ new product line, to or not to increase volume of sales etc etc

Cost concept
Cost plays a role in selection of alternatives. The kind of cost to be used in a situation depends on the business decisions to be made. Method of calculation in costing may not be similar in all product/situations. Different business problems calls for different kind of cost.

Cost concept
Cost of production of a commodity is the aggregate of price paid for the factors of production used in producing Value of input required in the production of a goods/service determines its cost of output Cost can be- real cost (real cost in production ) opportunity cost( based on scarcity & versatility
also known as alternative cost )

money cost (only monetary expenditures )

Types of cost -1
Future & past cost Fixed & variable cost (cost of additional - labour, raw material,
power, fuel etc)

Incremental ( differential cost- resulting from a contemplated change ) & sunk cost ( does not change due to change in level/nature of
business activities )

Out of pocket ( involves immediate payment to outsiders ) & book cost Replacement & historical costs Explicit cost( actually paid by firm ) & implicit or imputed cost( theoretical cost go unrecognized by accounting system )

Types of cost -1
ACTUAL COST & OPPORTUNITY COST SHUT-DOWN & ABANDONMENT COST PRIVATE & SOCIAL COST SHORT RUN & LONG RUN COST TOTAL COST (TC ) ,AVERAGE COST & MARGINAL COST (MC ) TC= TFC +TVC DIRECT ( SEPARABLE OR TRACEABLE )COST & INDIRECT ( COMMON OR NONTRACEABLE) COST

COST CURVES

TC
TVC

COST
OUT PUT

TFC

COST CURVE
COST PER UNIT IS DERIVED FROM THE TOTAL COST IT IS AFC,AVC,ATC & MC AFC DECREASES AS OUTPUT INCREASES TOTAL FIXED COST REMAINS SAME BUT AFC DECREASE AFC= TFC/ Q COST AFC
OUT PUT

COST CURVE
AVC FIRST DECREASES THEN INCREASES WITH INCREASE IN OUTPUT

COST

AVC

OUTPUT

COST CURVE
MC ALSO DECREASES INITIALLY & THEN INCREASES AS OUTPUT IS INCREASES
MC
COST

OUTPUT

Cost curve
ATC DECREASES INITIALLY THEN IT REMAINS CONSTANT FOR A WHILE THEN INCREASES WITH INCREASE IN OUTPUT
ATC

COST

OUTPUT

RELATIONSHIP OF MC TO AC

MC

A
COST B

M P

AC

N
OUT PUT

RELATIONSHIP OF MC ,ATC AND AVC

ALL THREE COST MEASURES FIRST FALL THEN REMAIN

CONSTANT & EVENTUALLY RISE AS OUT PUT INCREASES.

THE RATE OF CHANGE IN MC IS > AVC & HENCE MINIMUM MC ,LOWER THAN (IN A PERTICULAR OUTPUT AT WHICH) AVC IS MINIMUM THE ATC FALLS FOR A LONGER RANGE OF OUTPUT THAN THE AVC, HENCE AT A LARGER OUTPUT, MINIMUM ATC IS AHEAD OF AVC AVC= MC WHEN AVC IS THE LEAST ATC=MC, WHEN ATC IS THE LEAST

Production functions
Production is an activity , which transforms input in to output.by Change in form Change in space Change in time But we consider only two input labor & capital.(considering land as fixed ) Hence production function isQ =f(L.K)
Were Q= output, K= capital, L=labor

Production functions
TP=total quantity of output produced during a time period. AP=total output divided by the total quantity of inputs used. MP=extra product produced or added by using 1 extra unit of input while keeping all other inputs constant

MPL=TP/L
WERE MPL =MARGINAL PRODUCT OF LABOR,L=UNIT OF LABOR USED

Relation with AP MP & TP

TP IS MAXIMUM WHEN MARGINAL PRODUCT IS ZERO. THE AVERAGE PRODUCT ATTAINS ITS MAXIMUM POINT WHEN THE MARGINAL PRODUCT EQUALS AVERAGE PRODUCT

Production functions
Relation with AP MP & TP

total production total production labour

Marginal product & average product

Average production Marginal production

Production functions
Production functions is studies into four wayslaws of variable proportion return of scale economies of scale economies of scope

Laws of variable proportion

AP= TP/Q
WERE AP=average production , TP=total production , Q= number of variable factors

MP = <>TP/<>Q
WERE MP=MARGINAL production , <>TP= CHANGE IN total production , <>Q= CHANGE IN number of variable factors laws of variable proportion is also known as law of diminishing returns. It state that , when variable factors are increased in equal doses, keeping fixed factors constant, the total production will increase , but after certain point it will increase at a diminishing rate & finally it start decreasing.

Return of scale

2 MARGINAL RETURN 1 3

SCALE OF PRODUCTION

Economies of scale
WHEN LARGE OUTPUT IS ASSOCIATED,WITH LOW PER UNIT COST. INTERNAL ECONOMIES REAL- TECHNICAL ECONOMIES,
MARKETING ECONOMIES, MANAGERIAL ECONOMIES, RISK BEARING ECONOMIES ,ECONOMIES OF WELFARE, LOBOUR ECONOMIES

--PECUNIARY=MONETARY
INTERNAL ECONOMIES

Economies of scale

EXTERNAL ECONOMIES -- REAL (TECHNICAL

ECONOMIES, ECONOMIES OF INFORMATION & ECONOMIES OF BY PRODUCT)

- PECUNIARY( WHEN FIRM

ENJOY REDUCTION OF FACTOR PRICE )

Economies of scale
REAL
PRODUCTION MARKETING MANAGERIAL
PARTLY PROD+MKT

PECUNIARY
TRASPORTATION
&STORAGE

NEXT PAGE

PRODUCTION=LOBOR-SPS +SKILL,TIME SAVING, AUTOMATION,CUMULATIVE VOLUME ECO

= TECHNICAL CAPITAL-SPS , SET UP COST OF MACHINERY , INITIAL FIXED COST ,
TECH RELATION WITH MACHINERY INOUT &OUTPUT , RESERVE CAPACITY OF MACHINE &LOBOR

= INVENTORY ECONOMIESMATERIALS,READY PRODUCT

INVENTORY IN SPARE PARTS, RAW

MARKETING = ADV , LARGE SCALE PRODUCTION , DISTRIBUTION , OTHER FACTORS

MANAGERIAL =
SAVING TECHNIQUES SPS & TEAM WORK , EXPERIENCE ,DECENTRALIZATION , MECHANIZATION , TIME & TRANSPORTATION

TRASPORTATION & STORAGE = STORAGE

PECUNIARY
LOWER PRICE FOR BULK PURCHASE OF RAW MATERIALS LOWER COST OF FINANCE LOWER COST OF ADVERTISING AT LAGE SCALE LOWER TRANSPORT RATES LOWER WAGES & SALARY

Diseconomies of SCALE
When large output leads to higher per unit cost There is a limit to expand the scale of production A time comes when economies are taken by diseconomies

INTERNAL DISECONOMIESINTERNAL DISECONOMIESSOME INTERNAL DISECONOMIES AREMANAGERIAL DISECONOMIES TECHNICAL DISECONOMIES MARKETING DISECONOMIES WHEN A FIRM FACES PROBLEMS LIKE LACK OF CO ORDINATION, MANAGEMENT, MARKETING ETC

EXTERNAL DISECONOMIES-

WHEN THE PRICE OF FACTORS INCREASE DUE TO INCREASE IN DEMAND,IT IS IN TURNS INCREASE THE PER UNIT COST.DUE TO OVER GROWTH THERE IS SHORTAGE OF 4M, POWER, TRANSPORTATION,ETC

Economies of Scope
Efficiency in production process is brought by variety rather than volume. economies of scope are change in average cost because of change in mix of output between two or more product.(AC will reduced by producing many product)( joint production technique )

exercise
Calculate variable cost, average fixed cost , average variable cost , marginal cost total revenue & tell the output where cost minimum & the output where profit is maximum ? unit fixed cost total cost 2 200 250 3 200 300 4 200 350 5 200 400 6 200 450 7 200 500