Cost of Production and Revenue


Production: It is a process of transforming inputs to output.

Product/Output: The numbers of goods produced. For example if 1 car is produced, it is one unit of output, if 100 cars are produced, its 100 units of output. 

Factors involved in production

The factors involved in the production can classified as fixed factors and variable factors.

  1. Fixed Factors: The factors whose supply cannot be quickly or easily changed over a short period. It can only be changed over the long run.  Example: Factory Building, Heavy specialised machinery and Fixtures and Fitting
  2. Variable Factors: The factor supply can be easily changed both in short run and long run. Example: Labour, Raw materials, fuel, power and hand tools.


There are two time periods in Economics, short run and long run.
1.      The short run
-          Short run refers to a short period of time over which at least one factor would be fixed.
-          If a firm wants to change its output in the short run, they would be able to change only its variable factors to bring a change in its output.
-          There are fixed factors in the short run.
2.      The long run
-          Long run refers to a period of time over which the firm can change all its factors.
-          If a firm wants to change its output in the long run, they would be able to change all its factors.
-          There are no fixed factors in the long run. In the long run all the factors are variable.
Costs
Costs are expenses a firm has to bear during the process of the production. There are three types of costs. They are:

Fixed Costs: These are the costs of fixed factors of production. The cost of production does not vary with the change in the output. As firm increases or decreases the fixed always remain unchanged. Fixed costs are also known as indirect or overhead costs.  Examples: Rent, insurance premium, Managers Salary and interest payment on a loan. The diagram represents the fixed cost schedule a firm faces:   



 








Variable costs: Variable costs are cost of production which varies directly with the change in output. If more goods are produced cost of production is likely to increase. It is also known as direct costs. Examples: raw material costs, power linked in production, wages linked to production. The following diagram represents variable costs.   


 









Total Cost: Total cost of producing a given amount of goods and services.
-          When output increases the total cost also increases and vice-versa.
-          This is because when output increases, variable cost increases. So this increase in VC is also shown in the total cost.
Total cost can be calculated as follow:
Total Cost = Fixed Cost + Variable Costs

In a diagram it can be represented as follow:









Average Total Cost (AC/ATC)
ATC is the total cost per unit of output produced. It can be calculated by the following formula.


 




Average Fixed Cost (AFC): AFC is the fixed cost per unit of output. It can be calculated by the following formula:

 





Average Variable Cost (AVC): AVC is the average cost per unit of output. . It can be calculated by the following formula:

 




Marginal Cost (MC) : Marginal cost incurred by employing an additional unit of factor of production. . Marginal cost measure the change in total cost for an increase in one unit of output. The following two examples depict marginal costs of an increase in scale of production.
MC can be calculated by the following formula.


EXAMPLE 1:

Output
Total Cost
Marginal Cost
0
132
11
 
 22
 
 14
 
 11
 
 9
 
1
143
2
152
3
163
4
177
5
199

Always deduct the 2nd Number from the first number (143 – 132) to get the marginal cost. Write your answer between the two numbers.
 Fr example, 143-132
                        1-0
                  = 11/1
                  = 11


EXAMPLE 2:

Output
Total Cost
Marginal Cost
0
142
23
 
 35.5
 
 17
 
15
 
1.6
 
2
188
5
193
7
223
11
342
15
484
                  Here MC was calculated as:













 







                                                                                                                                 



 
The graph of Marginal cost can be shown as below.






                                                   




There are various features of MC curve to be noted. First it goes down till it reaches a minimum point and then keeps on increasing.
The Nature of the Marginal Cost (MC) and Average cost (AC) Curves

 















-          The marginal cost and the average cost is in “U” shape.
-          Initially, as output increases, MC and AC will be falling as cost can be shared among an increased number of outputs.
-          But if the output continues to increase after some point, the productivity starts to decline which increases the cost as more output is produced, hence MC and AC starts increasing.