Page 126 - DECO405_MANAGERIAL_ECONOMICS

Unit 8: Cost Analysis

Private and Social Costs Notes

Economic costs can be calculated at two levels: micro-level and macro-level. The micro-level
economic costs relate to functioning of a firm as a production unit, while the macro-level
economic costs are the ones that are generated by the decisions of the firm but are paid by the
society and not the firm. Private costs are those which are actually incurred or provided for by
an individual or a firm for its business activity. Social cost, on the other hand, is the total cost to
the society on account of production of a good. Thus, the economic costs include both private
and social costs.

Above are the some concepts of costs. But the important cost concepts which play crucial role in
managerial decision-making are as follows:

8.2 Fixed and Variable Costs

There are some inputs or factors which can be adjusted with the changes in the output level.
Thus, a firm can readily employ more workers if it has to increase output. Likewise, it can secure
and use more raw materials, more chemicals, without much delay, if it has to expand production.
Thus, labour, raw materials, chemicals are the factors which can be readily varied with the
change in output. Such factors are called variable factors. On the other hand, there are factors
such as capital equipment, building, top management personnel which cannot be readily varied—
it requires a comparatively long time to make variations in them. The factors such as capital
equipment, building, which cannot be readily varied and require a comparatively long time to
make adjustment in them are called fixed factors. Therefore, fixed costs are those which are
independent of output, i.e., they do not change with changes in output. These costs are a "fixed"
amount which must be incurred by a firm in the short run, whether the output is small or large.
Fixed costs are also known as overhead costs and include charges such as contractual rent,
insurance fee, maintenance costs, property taxes, interest on the capital invested, minimum
administrative expenses such as manager's salary, watchman's wages, etc. Thus, fixed costs are
those which are incurred in hiring the fixed factors of production whose amount cannot be
altered in the short run.
Variable costs, on the other hand, are those costs which are incurred on the employment of
variable factors of production whose amount can be altered in the short run. Thus, the total
variable costs change with changes in output in the short run. These costs include payments such
as wages of labour employed, the price of the raw material, fuel and power used, the expenses
incurred on transporting and the like. Variable costs are also called prime costs. Total cost of a
business firm is the sum of its total variable costs and total fixed costs. Thus, TC = TFC+TVC.
In Figure 8.1, output is measured on the X-axis and cost on Y-axis. Since the total fixed cost
remains constant whatever the level of output, the total fixed cost curve (TFC) is parallel to the
X-axis. This curve starts from a point on the Y-axis meaning thereby that the total fixed cost will
be incurred even if the output is zero. On the other hand, the total variable cost curve (TVC) rises
upward showing thereby that as the output is increased, the total variable costs also increase.
The total variable cost (TVC) starts from the origin which shows that when output is zero the
variable costs are also nil. It should be noted that total cost is a function of the total output, the
greater the output, the greater will be the total cost. In symbols, we can write:
TC = f(q)

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