<p> SUPPLEMENTARY MATERIAL & PRACTICE QUESTIONS</p><p>Cost of Production </p><p>Define production Production is the creation of utilities for the satisfaction of human wants. Here the four factors (agents) of production have to cooperate.</p><p>Production function: A technological relationship expressing the maximum quantity of a good attainable from different combinations of factor inputs.</p><p>Productivity: Output per unit of input, for example, output per labor hour.</p><p>Short run: The period in which the quantity (and quality) of some inputs cannot be changed.</p><p>Lon run: A period of time long enough for all inputs to be varied (no fixed cost) </p><p>Cost of productions refers to the total payments (rent + wages + interest + profit) to the four factors of production (land, labor, capital & organization)</p><p>Three concepts of costs:</p><p>1) Real cost: refers to the mental and physical exertion + the pain, sacrifice involved in producing a commodity or service.</p><p>2) Opportunity cost: The next best alternative forgone. </p><p>3) Money cost: Cost of production measured (or paid to the 4 factors) in terms of money.</p><p>Money cost is further divided into two: a) Explicit costs: Direct contractual payments made by an organization to the four factors of production. A payment made for the use of resources. e.g. Rent for land and factory building Wages to labor, interest for money borrowed from bank, etc. </p><p> b) Implicit costs:</p><p>The value of resources used, even when no direct payments is made. The costs of self-owned, self-supplied resources. E.g. the owner himself uses his own building as a factory for which rent need not be paid. He uses his own money instead of borrowing money from banks. </p><p>Short Run Costs : The short run cost of a firm is classified into Fixed costs & Variable cost. </p><p>1) Fixed costs: are the expenditures on fixed inputs used in production. E.g. Rent for land and factory building. (As land is a fixed factor). Fixed costs do not change even if the output is zero. Fixed costs remain fixed only in the short-run. </p><p>2) Variable costs: are the costs incurred on the variable inputs used in production. E.g. Raw materials, wages for labor, etc. Variable costs change with the level of production. When production is zero, VC is also zero.</p><p>Types of costs in the short run:</p><p>1) Total Cost (TC): Sum of total of fixed cost and total variable cost. TC = TFC + TVC</p><p>2) Total Fixed Cost (TFC): refers to the total expenditure on fixed factors of production. TFC remains same whatever be the volume of production.</p><p>3) Total Variable Cost (TVC): refers to the total expenditure on the variable factors. TVC = f (Q)</p><p>4) Average Fixed Cost (AFC): is obtained by dividing TFC by the total quantity of output (Q) AFC = TFC / Q 5) Average Variable Cost (AVC): calculated by dividing TVC by output (Q) AVC = TVC / Q.</p><p>6) Average Total Costs (ATC): is obtained by dividing TC by the Quantity of output. ATC = TC / Q Or ATC = AFC + AVC</p><p>7) Marginal Cost (MC): is the addition made to the total cost (TC) when one more unit is produced. (Hint: take the differenced in total costs) The increase in total cost associated with a one-unit increase in production</p><p>Change in cost Change in quantity OR MC = TCn – TCn-1 Exercises on short-run costs: </p><p>From the table given below, </p><p>Quantity TFC TVC= TC AFC AVC ATC MC (the of output + = TFC / Q = TVC/Q = TC / Q differ ences in TC) 0 5 0</p><p>1 5 5</p><p>2 5 7</p><p>3 5 10</p><p>4 5 14</p><p>5 5 19</p><p>1) Calculate the various short-run costs and draw graphs of TFC, TVC, TC on one graph sheet and commend on each curve.</p><p>2) Draw the graphs of AFC, AVC, ATC, MC on another graph and commend on each curve.</p><p>3) Show the relationship between Marginal Cost (MC) and Average Total Cost (ATC) with help of a diagram. Hint:</p><p>1) When MC is below AC, it pulls the AC down and AC also falls.</p><p>2) MC cuts the AC curve through its minimum point. MC = AC</p><p>3) When MC is above AC, it pulls the AC up and AC also rises. Long run costs: </p><p>All the factors are variable in the long period. Nothing is fixed in the long run. The firm can change its plant capacity. Since all factors are variable in the long run, there are only variable costs in the long run. In the long run we see only the Long Run Average Cost (LRAC), Long Run Marginal Cost (LRMC).</p><p>How to derive the Long Run Average Cost Curve (LRAC)?</p><p>It is also called as the “envelope curve” or “planning curve” because it envelopes a number of SRACs. It is called a “planning curve” because the firm plans its plant capacity on the basis of the behavior of LRAC.</p>