1. COST AND REVENUE FUNCTIONS, SHORT RUN COST CURVES, AND LONG RUN COST
CURVES.
Cost of Production
Meaning:
Cost of Production refers to the total money expenses(both explicit and implicit)
incurred by the producers in the process of transforming inputs into outputs.
Cost is analyzed from the producers point of view .Cost estimates are always made in
terms of money.
Cost Concepts
A. Money Cost and Real Cost
When cost of production is expressed in terms of money, it is called as money cost.
If the cost is expressed in terms of physical efforts or mental efforts put in by various
people in the production of a commodity, it is called as real cost.
B. Explicit Cost and Implicit Cost
Explicit cost refer to the actual money outlay or out of pocket expenditure of the firm
to buy or hire the productive resources it needs in the process of production.
The following items of a firms expenditure are explicit money costs.
1. Cost of raw materials
2. Wages and Salaries
3. Power charges
4. Rent of Factory Premises
5. Interest Payment on Capital
6. Insurance premium
7. Property Tax, License Fee etc
8. Miscellaneous Business expenses like Marketing and Advertising expenses.

2. Implicit costs are payments which are not actually paid by the firm. Such costs arise when the
entrepreneur supplies certain factors owned by himself.
The implicit money costs are as follows:
Wages for labour rendered by the entrepreneur himself
Interest on capital supplied by him.
Rent for his own building used in production
Profits of enterpreneur
Depreciation C. Outlay Costs and Opportunity costs
Outlay cost is the actual financial expenditure of the firm. It is recorded in the firm’s
books of account.
For example, Payment of wages, interest, cost of raw materials, machines, etc.
Opportunity cost of the given economic resources is the foregone benefits from the
next best alternative use of that resource.
D. Short run and Long run Costs
On the basis of span of time in production , costs can be classified into short run costs
and long run costs.
Short run costs are the costs which vary with output in the short period when plant,
machinery, etc remain fixed.
Long run costs are the costs which vary with output when all inputs including plant,
machinery, etc vary.
Cost– Output Relationship
 Cost-output relationship refers to the relationship between output and costs and the
behaviour of costs in relation to the change in output.
 The relationship between cost and output is described as the “ cost function”.
TC = f(Q) Where TC --- Total cost of production
Q --- Quantity of output produced
Cost Function
The cost function depends on the three independent variables:

3. 1. Production function
2. Market prices of inputs
3. Period of time
Types of Cost FunctionsIn economic theory there are mainly 2 types of cost functions. They are:
Short run cost function
Long run cost function
Cost output relationships or cost behaviour is discussed for the short period and the
long period separately.
When this relationship is represented with the help of diagram we get the short and long run
cost curves.
Meaning Of Short Run
Short run is a period of time in which only the variable factors can be varied. While the
fixed factors like plant, machinery, management, etc remain constant. The total no of firms in an
industry will remain the same.
Cost—Output Relationship And The Behaviour Of Cost Curves In The Short Run
Cost Schedule:
A Cost Schedule is a list or statement showing variations in costs resulting from
variations in the levels of output.
It shows the response of cost to changes in output.
On the basis of the cost schedule we can analyse the relationship between changes in
the level of output and cost of production.

4. 1. Total Fixed Cost (TFC)
Total Fixed Costs refers to the total money expenses incurred on fixed inputs like
Plant, machinery , tools and equipments in the short run. They are fixed in nature. They are the
costs a firm has to incur even when the output is zero.
Matthematically,
TFC = TC – TVC
where TVC = Total Variable Cost
TC = Total Cost

5. 2. Total Variable Cost (TVC)
Total Variable Cost refers to the total money expenses incurred on variable
factor inputs like raw materials, electricity, fuel, transportation, advertisement, etc in the
short run. The variable cost vary directly with the output.
TVC = TC – TFC
3. Total Cost (TC)
Total cost refers to the aggregate money expenditure incurred by a firm to
produce a given quantity of output.

6. Mathematically, TC = f(Q)
which means that total cost varies with level of output.
TC = TCF + TVC.
TC varies in the same proportion as in TVC. The behaviour of TFC, TVC & TC are
shown in the following diagram.
4. Average Fixed Cost (AFC) is the fixed cost per unit of output produced. It is found out by
dividing the total fixed cost by total output.
AFC = TFC Q
Where ‘Q’ represents output.
An important character of AFC is that it goes on decreasing as output increases since
the amount of total fixed cost is being divided by larger no. of units of output produced. The
greater the output the smaller will be the average fixed cost.

7. Average variable cost (AVC) is the variable cost per unit of output. It is found out by dividing
the total variable cost by the total output.
AVC =TVC
Q
where ‘Q’ represents the total output.
An important character of AVC is that it will decline in the beginning as output
increase, but when a certain stage is reached it stops declining. This is the stage when the
stage has reached its full capacity of production.

8. 6. Average cost (AC) is the cost per unit of the output. This is found out by dividing the total
cost by the total output. Since the total cost consists of fixed cost & variable cost, the average
cost will be equal to the sum of average fixed cost & average variable cost.
AC = TC / Q = TC / Total output.
= FC + VC / Total output.
= TFC + TVC / Q
Where ‘Q’ stands for the total output.
= AFC + AVC.

9. The Behaviour of AFC,AVC and AC
In the short run the AC curve tends to be U-shaped. The combined influence of AFC
and AVC curves will shape the nature of AC curve.
AFC begins to fall with an increase
in output.
AVC comes down upto a particular level and then rises.

10. 7. Marginal Cost (MC)
Marginal costs may be defined as the net addition to the total cost as one more unit
of output is produced.
It implies additional cost incurred to produce an additional unit.
MC = change in TC
change in TQ
Where TC = Total cost
TQ = Total output.
Or
MC = TCn — TCn-1

12. Relationship between MC and AC
1. When AC is falling , MC is also falling. When AC and MC curves are falling MC curve is lies
below the AC curve.
2. When Ac is minimum, the MC=AC.
3. Once MC=AC, when both the costs are rising , MC curve will always lie above the AC curve.
Cost–Output Relationship in the Long Run
 Long period is a period during which the quantities of all factors variable as well as fixed
factors can be varied according to the requirements.
 In the long run a firm is not tied upto a particular plant capacity. If the demandincreases, it
can expand output by enlarging its plant capacity.
 If the demand for the product declines , a firm can cut down its production capacity. Hence
production cost comes down to a great extent in the long run.
 As all costs are variable in the long run , the total of these costs is the total cost of production.
 In the long run only average cost is important and considered in taking long term output
decisions.
 Long run average cost= TC

13. Output
It is the per unit cost of production at different levels of output by changing the size of
the plant.
 The long run cost output relationship is explained by drawing a long run cost curve through
short run cost curves.
 The long run cost curve is influenced by the Laws of Returns To Scale.
 The long run cost curve explains how costs will change when the scale of production varies.
Important Features of LAC Curve
1. Tangent Curve
2. Envelope Curve
3. Planning Curve
4. Flatter U Shaped Curve
Long Run Marginal Cost Curve
The long run marginal cost curve is derived from long run total cost curve at the
various points relating to the given level of output at each time.

14. The LMC curve also has a flatter U- shape, indicating that initially as output expands in
the long run with the increasing scale of production , LMC tends to decline. At a certain stage however
LMC tends to increase.
REVENUE CONCEPTS
The amount of money which a firm receives by the sale of its output in the market is
known as its revenue.
The revenue concepts commonly used in economics are
1. Total revenue
2. Average revenue
3. Marginal revenue
1. Total Revenue
Total revenue refers to the total amount of money that the firm receives from the sale
of its products.
The TR can be calculated by following formula:
TR = Q x P
where TR = Total revenue
Q = Quantity of output
P = Price per unit of the Commodity

15. 2. Average Revenue
Average revenue can be obtained by dividing the total revenue by the number of units
sold.
AR = TR
Q
where AR is the revenue earned per unit of commodity sold. AR is the price of the commodity.
The price paid by the consumer is the revenue realised by the producer.
3.Marginal Revenue
Marginal revenue refers to the additional revenue earned by selling the
additional unit of output by the seller.
Mathematically,
MR = TRn – TRn-1
Or
MR = change in TR
change in Q