Concepts of Cost — Notes

• Explicit cost: payment to outsiders (wages, materials, rent paid).
• Implicit cost: imputed value of the owner's own factors (own shop, savings, time); not in the books.
• Economic cost = explicit + implicit.
• Money cost: rupee spending. Real cost: toil, risk and sacrifice of factor owners.
• Private cost: cost borne by the firm. Social cost = private cost + external cost imposed on others.

Opportunity cost = value of the next best alternative forgone. A resource with no alternative use has zero opportunity cost.

Accounting profit = revenue − explicit costs. Economic profit = accounting profit − implicit costs. A firm can show an accounting profit yet make an economic loss.

TFC: does not change with output; horizontal line; paid even at zero output.

TVC: zero at zero output; rises first at a decreasing rate, then at an increasing rate.

TC = TFC + TVC: same shape as TVC, starting at the TFC level; the vertical gap TC − TVC = TFC is constant.

AFC = TFC ÷ Q (rectangular hyperbola). AVC = TVC ÷ Q. AC = TC ÷ Q = AFC + AVC. MC = TCn − TCn−1 = TVCn − TVCn−1; fixed cost does not affect MC.

To complete a schedule: from TC subtract TFC; from AVC multiply by Q; from MC add up successive values.

• MC below an average → the average falls; MC equal → average at its minimum; MC above → average rises.
• MC therefore cuts AVC and AC at their lowest points; MC reaches its own minimum first, then AVC, then AC.
• AC − AVC = AFC, so the curves approach each other but never meet.
• U-shapes in the short run come from the law of variable proportions.

In the long run all factors are variable, so all costs are variable and there is no AFC.

Each plant size has its own SAC. The LAC shows the lowest average cost of each output when the best plant is chosen; it touches every SAC from below and is called the envelope or planning curve. It is flatter than any SAC and U-shaped because of economies and then diseconomies of scale. (Derivation of the curves is not required.)