Cost-output Relationship

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# Cost-output Relationship - PowerPoint PPT Presentation

Cost-output Relationship. Cost-output relationship has 2 aspects: Cost-output relationship in the short run, Cost-output relationship in the long run The SR is a period which doesn’t permit alterations in the fixed equipment (machinery , building etc) &amp; in the size of the org.

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### Cost-output Relationship

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Cost-output relationship has 2 aspects:

• Cost-output relationship in the short run,
• Cost-output relationship in the long run
• The SR is a period which doesn’t permit alterations in the fixed equipment (machinery , building etc) & in the size of the org.
• The LR is a period in which there is sufficient time to alter the equipment (machinery, building, land etc.) & the size of the org. output can be increased without any limits being placed by the fixed factors of production

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Short Run may be studied in terms of

• Average Fixed Cost
• Average Variable Cost
• Average Total cost

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Total, average & marginal cost

1. Total cost (TC) = TFC + TVC, rise as output rises

2. Average cost (AC) = TC/output

3. Marginal cost (MC) = change in TC as a result

of changing output by one unit

• Fixed cost & variable cost

1.Total fixed cost (TFC) = cost of using fixed factors = cost that does not change when output is changed, e.g.

2. Total variable cost (TVC) = cost of using variable factors = cost that changes when output is changed,

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Average Fixed Cost and Output

• The greater the output, the lower the fixed cost per unit, i.e. the average fixed cost.
• Total fixed costs remain the same & do not change with a change in output.

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Average Variable Cost and output

• The avg. variable costs will first fall & then rise as more & more units are produced in a given plant.
• Variable factors tend to produce somewhat more efficiently near a firm’s optimum output than at very low levels of output.
• Greater output can be obtained but at much greater avg variable cost.
• E.g. if more & more workers are appointed, it may ultimately lead to overcrowding & bad org. moreover, workers may have to be paid higher wages for overtime work.

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Average Total cost and output

• Average total cost, also known as average costs, would decline first & then rise upwards.
• Average cost consists of average fixed cost plus average variable cost.
• Average fixed cost continues to fall with an increase in output while avg. variable cost first declines & then rises.

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So , as Avg. variable cost declines the Avg. total cost will also decline. But after a point the Avg. variable cost will rise.

• When the rise in AVC is more than the drop in Avg. fixed cost that the Avg. total cost will show a rise.

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long run period enables the producers to change all the factor & he will be able to meet the demand by adjusting supply. Change in Fixed factors like building, machinery, managerial staff etc..

• All factors become variable in the long run.
• In the long run we have only 3 costs i.e. total cost, Average cost & Marginal Cost

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1. Total cost (TC) = TFC + TVC, rise as output rises

2. Average cost (AC) = TC/output

3. Marginal cost (MC) = change in TC as a result

of changing output by one unit

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When all the short run situations are combined, it forms the long run industry.

• During the SR, Demand is less & the plant’s capacity is limited. When demand rises, the capacity of the plant is expanded.
• When SR avg. cost curves of all such situations are depicted, we can derive a long run cost curve out of that.
• We can make a LR cost curve by joining the tangency points of all SR curves

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• In the long run, we can build any size factory we wish, based on anticipated demand, profits, and other considerations.
• Once the plant is built, we move to the short run. Therefore, it is important to forecast the anticipated demand. Too small a factory and marginal costs will be high as the factory is stretched to over produce.
• Conversely too large a factory results in large fixed costs (e.g.. air conditioning, or taxes) and low profitability.

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Thank You

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