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Cost-output Relationship

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) & in the size of the org.

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Cost-output Relationship

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  1. Cost-output Relationship www.mbaknol.com

  2. 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 www.mbaknol.com

  3. Cost-output Relationship In The Short Run www.mbaknol.com

  4. Short Run may be studied in terms of • Average Fixed Cost • Average Variable Cost • Average Total cost www.mbaknol.com

  5. 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, www.mbaknol.com

  6. 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. www.mbaknol.com

  7. 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. www.mbaknol.com

  8. 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. www.mbaknol.com

  9. 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. www.mbaknol.com

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  11. Cost-output Relationship In The Long-Run www.mbaknol.com

  12. 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 www.mbaknol.com

  13. 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 www.mbaknol.com

  14. 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 www.mbaknol.com

  15. We use long run costs to decide scale issues, for example mergers. • 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. www.mbaknol.com

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  17. Thank You www.mbaknol.com

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