presentation of cost output Analysis.ppt

Cost-output Relationship
&
Economies & Diseconomies of
Scale

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

Cost-output Relationship In The
Short Run

Short Run may be studied in terms of
 Average Fixed Cost
 Average Variable Cost
 Average Total cost

 Total, average &
Total, average &
marginal cost
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 &
Fixed cost &
variable 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,

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.

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.

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.

 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.

Cost-output Relationship In
The Long-Run

 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

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

 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

 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.

Economies & Diseconomies
Of
Scale

 When a firm expands its size & goes for
large scale production, it stands to enjoy
certain benefits. Such advantages which
arise due to large scale production are
known as economies of scale.
 According to Marshal, there are 2 types of
economies of scale. They are
 Internal Economies of Scale
 External Economies Of Scale

 Internal economies Of scale: IE are those
advantages of large-scale production which
accrue to a firm on account of its superior
techniques & management. Following are
some of the IE of scale.
 Technical Economies
 Managerial Economies
 Marketing Economies
 Financial Economies
 Risk bearing Economies of scale

 External economies Of scale: when a
particular industry grows in size & strength, it
brings many advantages to all the firms within
that industry. Those advantages which are
available to all the firms are called the EE of
scale. Following are some of the EE of scale.
 Economies of Localisation
 Economies of Information
 Economies of Specialisation

Diseconomies refer to the disadvantages
suffered by a firm when it expands its
production beyond the stage of optimum
combination of factors or beyond the level of
optimum output. Following are such
diseconomies of scale:
 When the firm expands production beyond
certain level. It develops many complexities.
Effective management & smooth co-
ordination at different levels become difficult.

 Beyond the stage of optimum production, the
efficiency of machinery & equipment
declines. This is called the technical
diseconomy
 Beyond certain point, the firm is compelled
to pay higher wages to recruit labour.
Consumption of raw material becomes
costlier. It faces the problem of shortage of
fuel, power, finance etc.

" VALUE HAS A VALUE
ONLY IF ITS VALUE IS
VALUED "
References:
1.Managerial economics – KL Maheshwari
2.Rferesher course by Kamaraj
3. Managerial economics – D.N.Dwivedi

presentation of cost output Analysis.ppt

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