Cost of Production

•Production costs refer to the costs a company incurs

from manufacturing a product or providing a service
that generates revenue for the company.
•Production costs can include a variety of expenses,
such as labor, raw materials, consumable
manufacturing supplies, and general overhead.
Short-run production costs:
• The quantity of one production factor or input
remains fixed, while other factors may vary.
• In short run cost, production factors such as
machinery and land remain unchanged.
• On the other hand, other production factors, such
as capital and labour, may vary.
Different Types of Short Run Cost:
• There are primarily three types of short run costs –
Short Run Total Cost:
• The total cost borne by a firm for the production of
a given level of output is referred to as short-run
total cost.
• It comprises two components – Total Fixed Cost
(TFC) and Total Variable Cost (TVC).
• The short run cost is found out by adding the total
variable cost with the total fixed cost.
• As the TFC remains constant, all changes in the
short-run total cost are due to the changes in the
total variable cost.
Short Run Average Cost (SRAC) :
• The cost of per unit output at various production
levels of a firm.
• The calculation of average cost is done by division
of the total cost of the produced units.
 Short Run Marginal Cost:
• Short run marginal cost is the change in total cost
when an additional output is produced in the short
run and some costs are fixed.
Long-run production costs:
• The long run is the period during which all inputs
are variable.
• It is the least cost of producing a given level of
output.
• Thus, it can be less than or equal to the short run
average costs at different levels of output but never
greater.
• Difference between short run and long run in
production:
• The short run production function can be
understood as the time period over which the firm
is not able to change the quantities of all inputs.
 There are basically three types of long run costs:
• Long Run Total Cost.
• Long Run Average Cost.
• Long Run Marginal Cost.
• There is no distinction between the Long run Total
Costs (LTC) and long run variable cost as there are
no fixed costs.
• It should be noted that the ability of an organization
of changing inputs enables it to produce at lower
cost in the long run.
 Long Run Total Cost:
• Long run Total Cost (LTC) refers to the minimum cost
at which given level of output can be produced.
• The long run total cost of production is the least
possible cost of producing any given level of output
when all inputs are variable.
• LTC represents the least cost of different quantities
of output.
• LTC is always less than or equal to short run total
cost, but it is never more than short run cost.
 Long Run Average Cost:
• Long run Average Cost (LAC) is equal to long run
total costs divided by the level of output.
• The long-run average cost (LRAC) curve shows the
firm's lowest cost per unit at each level of output,
assuming that all factors of production are variable.
• The LRAC curve assumes that the firm has chosen
the optimal factor mix, as described in the previous
section, for producing any level of output.
• These lower costs represent an improvement in
productive efficiency and can give a business a
competitive advantage in a market.
• They can lead to lower prices for consumers and
higher profits / dividends for shareholders.
Long Run Marginal Cost:
• Long run Marginal Cost (LMC) is defined as added
cost of producing an additional unit of a commodity
when all inputs are variable. This cost is derived
from short run marginal cost. On the graph, the
LMC is derived from the points of tangency
between LAC and SAC.
 Economies of scale:
• Economies of scale refer to the cost advantage
experienced by a firm when it increases its level of
output.
• The advantage arises due to the inverse relationship
between the per-unit fixed cost and the quantity
produced.
• The greater the quantity of output produced, the
lower the per-unit fixed cost.
• The term "scale" is highly applicable in a discussion
of line production and costs, on both sides of the
seller and buyer equation.
• Usually, the more a business grows and the more
products it manufactures, the lower the price of
producing that product becomes.
• Think of a retailer who buys soap on bulk, from a
soap manufacturer. That retailer can usually count
on getting a price break by purchasing the soap in
large quantities. After receiving a price discount,
that retailer can sell the soap at a lower price than
competitors, thus insuring more customers and
more profits.
• There are two types of economies of scale: internal
and external economies of scale.
Diseconomies of scale:
• Diseconomies of scale happen when a company
or business grows so large that the costs per unit
increase. It takes place when economies of scale no
longer function for a firm.
• With this principle, rather than experiencing
continued decreasing costs and increasing output, a
firm sees an increase in costs when output is
increased.