COST OF PRODUCTION

COST OF PRODUCTION
Fixed and Variable Factors
 The factors which cannot be changed in the form in the process of production is known as fixed factors. Eg: machinery
 The factors which can be changed in the process of production is called variable factors Eg: raw materials
Short run and Long run
 Short run is the period of time in which at least one factor is fixed and others are variable
 Long run is the period of time in which all factors are variable, there is no fixed factors.
Fixed Cost
 Fixed cost is the cost which do not change according to the changes in out put
 Eg: rent on factory building, interest on bank loan, insurance pemium
Whatever may be the level of out put it will be remaining the same.
Variable cost
 Variable cost is the cost which changes according to the changes in out put
 Eg: cost of raw materials, electricity charge etc
It will vary directly with the changes in output.

Total cost
 It is the sum of fixed cost and variable cost
 Total cost = Fixed cost + Variable cost
Average cost
 Average cost is the cost per unit of an out put.
 It is the cost for producing one unit of an out put
 Average cost = Total cost / out put
Marginal cost
 It is the cost for producing additional units of an out put.
 It is the change in total cost by the changes in an out put.
 Marginal cost = ΔTC / Δ out put
Average fixed cost
 Average fixed cost = Total fixed cost / Out put
Average variable cost
 Average variable cost = Total variable cost / Out put
Total revenue
 It is the total income received from the sale of all the units of an out put.
 Total revenue = Price x Out put
Average revenue
 It is the revenue per unit of an out put
 It is the income received from the sale of one unit of an out put
 Average revenue = Total revenue/ Out put
Marginal revenue
 It is the income received from the sale of an additional unit of an out put.
 Marginal revenue = Δ Total revenue/ Δ Out put
Profit maximization theory
The main aim of a firm is to maximize the profit. Profit is the difference between total revenue and total cost (Profit = Total revenue – Total cost). Profit maximization is possible only by reducing total cost and by increasing total revenue.