In order to extend the assembly of output, the firm must use a lot of the variable inputs. As a result, the total variable value and total value can increase.
Therefore, as the output will increase, the total variable value and total increase.
In the table below, there is an example of the cost function of a typical firm. The first column shows different levels of output.
For all levels of output, the total fixed cost is Rs 20.
Total variable cost increases as output increases. With output zero, TVC is zero.
For one unit of output, TVC is Rs 10; for 2 units of output, TVC is Rs 18 and so on.
In the fourth column, we obtain the total cost (TC) as the sum of the corresponding values in the second column (TFC) and third column (TVC).
At zero level of output, TC is just the fixed cost, and hence, equal to Rs 20. For 1 unit of output, the total cost is Rs 30; for 2 units of output, the TC is Rs 38 and so on.
The short-run average cost (SAC) incurred by the firm is outlined because of the total cost per unit of output. We calculate it as
SAC = TC/ q.
In the Table below, we get the SAC-column by dividing the values of the fourth column by the corresponding values of the first column. At zero output, SAC is undefined.
For the primary unit, SAC is Rs 30; for two units of output, SAC is Rs nineteen and then on.
Similarly, the common variable value (AVC) is outlined because of the total variable value per unit of output. We calculate it as
AVC = TVC /q
Also, average fixed cost (AFC) is
AFC = TFC/ q
SAC = AVC + AFC.
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In the Table below, we get the AFC-column by dividing the values of the second column by the corresponding values of the first column.
Similarly, we have a tendency to get the AVC-column by dividing the values of the third column by the corresponding values of the primary column. At zero level of output, each AFC and AVC square measure undefined. For the primary unit of output, AFC is Rs twenty and AVC is Rs ten. Adding them, we have a tendency to get the SAC adequate Rs 30.
The short-run marginal cost (SMC) is defined as the change in total cost per unit of change in output SMC = change in total cost/ change in output
where Δ represents the change of the variable.
If output changes in distinct units, we may define the marginal cost in the following way.
Let the cost of production for q1 units and q1 – 1 unit of output be Rs 20 and Rs 15 respectively. Then the marginal cost that the firm incurs for producing q1th unit of output is
MC = (TC at q1) – (TC at q1 – 1)
= Rs 20– Rs 15 = Rs 5
Just like the case of marginal product, monetary value is also undefined at zero levels of output.
It is necessary to notice here that within the short run, the fixed cost cannot be changed.
When we change the level of output, whatever change occurs to total cost is entirely due to the change in total variable cost. So in the short run:
Various Concepts of Costs, Production, and Costs run, marginal cost is the increase in TVC due to increase in production of one extra unit of output.
For any level of output, the sum of marginal costs up to that level gives us the total variable cost at that level. One might need to examine this from the instance represented through Table. Average variable value at some level of output is so, the average of all marginal costs up to that level.
In Table above, we see that when the output is zero, SMC is undefined.
For the primary unit of output, SMC is Rs 10; for the second unit, the SMC is Rs eight and then on.
Shapes of the Short Run Cost Curves
Now let us see what these short-run cost curves look like in the output cost plane.
We know that in order to increase the production of output the firm needs to employ more of the variable inputs. This results in an increase in total variable cost, and hence, an increase in total cost.
Therefore, as output increases, total variable cost and total cost increase Total fixed cost, however, is independent of the amount of output produced and remains constant for all levels of production shapes of total fixed cost, total variable cost and total cost curves for a typical firm. TFC is a constant which takes the value c1 and does not change with the change in output. It is, therefore, a horizontal straight line cutting the cost axis at the point c1.TFC is constant. Therefore, as q increases, AFC decreases. When an output is very close to zero, AFC is arbitrarily large, and as output moves towards infinity, AFC moves towards zero. AFC curve is, in fact, a rectangular hyperbola. If we multiply any value q of output with its corresponding AFC, we always get a constant, namely TFC. the shape of the average fixed cost curve for a typical firm. We measure output along the horizontal axis and AFC along the vertical axis. At q1 level of output, we get the corresponding average fixed cost at F. The TFC can be calculated as
TFC = AFC × quantity
= the area of the rectangle
Concepts of Cost and Revenue
Revenue in simple word means profit or the sale proceeding are known as revenue. Revenue is of 3 types:
- Total revenue
- Average revenue
- Marginal revenue
This is simple. The Total Revenue of a firm is the amount received from the sale of the output. Therefore, the total revenue depends on the price per unit of output and the number of units sold. Hence, we have
TR = Q x P
- TR – Total Revenue
- Q – Quantity of sale (units sold)
- P – Price per unit of output
Average Revenue, as the name suggests, is the revenue that a firm earns per unit of output sold. Therefore, you can get the average revenue when you divide the total revenue with the total units sold. Hence, we have,
- AR – Average Revenue
- TR – Total Revenue
- Q – Total units sold
Marginal Revenue is the amount of money that a firm receives from the sale of an additional unit. In other words, it is the additional revenue that a firm receives when an additional unit is sold. Hence, we have
MR = TRn – TR
- MR – Marginal Revenue
- ΔTR – Change in the Total revenue
- ΔQ – Change in the units sold
- TRn– Total Revenue of n units
- TRn-1– Total Revenue of n-1 units
MR pertains to a change in TR only on account of the last unit sold. On the other hand, AR is based on all the units that the firm sells. Therefore, even a small change in AR causes a much bigger change in MR. In fact, when AR reduces; MR reduces by a far greater margin.
Similarly, when AR increases, MR increases by a greater extent too. AR and MR are equal only when AR is constant. It is also important to note that the firm does not sell any unit if the TR or AR becomes either zero or negative. However, there are times when the MR is negative (especially if they fall in price is big).
The Relationship between TR, AR, and MR
In order to understand the basic concepts of revenue, it is also important to pay attention to the relationship between TR, AR, and MR. when the first unit is sold, TR, AR, and MR are equal.
Therefore, all three curves start from the same point. Further, as long as MR is positive, the TR curve slopes upwards.
However, if MR is falling with the increase in the quantity of sale, then the TR curve will gain height at a decreasing rate. When the MR curve touches the X-axis, the TR curve reaches its maximum height.
Further, if the MR curve goes below the X-axis, the TR curve starts sloping downwards.
Any change in AR causes a much bigger change in MR. Therefore, if the AR curve has a negative slope, then the MR curve has a greater slope and lies below it.
Similarly, if the AR curve has a positive slope, then the MR curve again has a greater slope and lies above it. If the AR curve is parallel to the X-axis, then the MR curve coincides with it.
Here is a graphical representation of the relationship between AR and MR:
In the left half, you can see that AR has a constant value (DD’). Therefore, the AR curve starts from point D and runs parallel to the X-axis. Also, since AR is constant, MR is equal to AR and the two curves coincide with each other.
In the right half, you can see that the AR curve starts from point D on the Y-axis and is a straight line with a negative slope. This basically means that as the number of goods sold increases, the price per unit falls at a steady rate.
Similarly, the MR curve also starts from point D and is a straight line as well. However, it is a locus of all the points which bisect the perpendicular distance between the AR curve and the Y-axis. In the figure above, FM=MA.
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Tag – Cost and Revenue, Cost / Concepts of Cost and Revenue / NCERT Class 12 Economics, Online Education, Class 11 Economics