Unit 3 2 CostOutput Relationship CostOutput Relationship in

COST-OUTPUT RELATIONSHIP � A proper understanding of the nature and behavior of costs is

The cost-output relationship plays an important role in determining the optimum level of production.

COST-OUTPUT RELATIONSHIP IN THE SHORT RUN Short-run is a period which does not permit

AVERAGE FIXED COST & OUTPUT � If output increase then Fixed cost per unit

AVERAGE VARIBLE COST & OUTPUT � Average Variable Cost will fall first and then

AVERAGE TOTAL COST & OUTPUT � AVG commonly known as AVERAE COST. � Decrease

COST-OUTPUT RELATIONSHIP IN THE LONG RUN Long-run is a period in which there is

� In the long-run, all cost make variable, including such costs as are fixed

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Unit 3. 2 Cost-Output Relationship : Cost-Output Relationship in the short run; Cost-Output Relationship in the long run; cost functions 1

COST-OUTPUT RELATIONSHIP � A proper understanding of the nature and behavior of costs is a must for regulation and control of cost of production. The cost of production depends on money forces and an understanding of the functional relationship of cost to various forces will help us to take various decisions. Output is an important factor, which influences the cost. 2

The cost-output relationship plays an important role in determining the optimum level of production. Knowledge of the cost-output relation helps the manager in cost control, profit prediction, pricing, promotion etc. The relation between cost and its determinants is technically described as the cost function. C= f (S, O, P, T …. ) Where; � C= Cost (Unit or total cost) � S= Size of plant/scale of production � O= Output level � P= Prices of inputs � T= Technology 3

COST-OUTPUT RELATIONSHIP IN THE SHORT RUN Short-run is a period which does not permit alternation in the fixed equipment. (machinery, building) In economic theory, the cost-output relationship in the short-run is studied in terms of � Average Fixed Cost � Average Variable Cost � Average Total Cost 4

AVERAGE FIXED COST & OUTPUT � If output increase then Fixed cost per unit decrease. � The reason, Total fixed cost remains the same with a change in OUTPUT. 5

AVERAGE VARIBLE COST & OUTPUT � Average Variable Cost will fall first and then rise as more and more units are produced. � Variable cost increase when number of units increased. 6

AVERAGE TOTAL COST & OUTPUT � AVG commonly known as AVERAE COST. � Decrease first and then rise UPWARDS. 7

COST-OUTPUT RELATIONSHIP IN THE LONG RUN Long-run is a period in which there is a sufficient time to alter the equipment and size of an organization. In order to study the cost-output relationship in the long-run, it is necessary to explain the concept of long- run cost. 8

� In the long-run, all cost make variable, including such costs as are fixed in the shortrun. � In the long-run, there is more chances for variations in output. � No fixed cost, the firm has sufficient time to alter its plant. 9