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05_COST AND REVENUE class 12

 

COST

The expenses incurred on the factors of production are known as cost of production. Cost of product on a good in economics, is the sum of all the direct and indirect expenditure on inputs and a certain minimum profits.

COST FUNCTION

It is the functional relationship between cost and output. C = f(Q)

KINDS OF COST

  1. Explicit Cost :These costs are incurred by the firms, when it puchases or hires factors of production for production process. The explicit costs are included in the accounts books of the firms. There are also known as money cost.
  2. Implicit Cost :Implicit cost are the imputed cost of using factors of production that firm owns. There are not in the monetary terms. For e.g. if any owner uses his own land for production, than the firm does not need to pay any rent. This is the opportunity cost involved in using the land owned.
  3. Normal Profits :An entrepreneur wants a certain min return or profit from a production process to keep them in the business in the long run. It is called normal profits.

Economic Cost Þ Explicit Cost + Implicit Cost

Cost in economics includes total expenditure on inputs i.e. explicit cost and imputed value of the inputs supplied but owner i.e. implicit cost.

TOTAL VARIABLE COST

Variable costs are those costs which vary with the change in output. These are the costs which are incurred on the employment of variable factor. Such as labour, fuel, transportation etc. examples are : –

  1. Wages of temporary staff.
  2. Payment of raw material.
  3. Payment of fuel and powers.
  4. Interest on short term loans.
  5. Excise duties
  6. Wear and tear of machines (Depreciation).

SHAPE OF VARIABLE COST

The shape of TVC is inverse S-shaped. This shape depends on law of variable proportion.

The TVC starts from the origin when output produced is zero. As per the law of variable proportion, when TP increases at increasing rate, TVC increases at diminishing rate. This happens in between the range O and A.

When TP increases at diminishing rate the TVC rises at increasing rate. This happens beyond the point A. An increase in the use of input raises the cost beyond the rise in output. Those raises are also called prime cost.

TVC Schedule  
Output TVC
1 15
3 20
3 24
4 27
5 29
6 32
7 36
8 41
9 47

 

TOTAL FIXED COST

Fixed costs are those costs of production which do not change with the change in output. They have to be incurred, when the output is zero large or small. These cost are also called supplementary cost, general cost, overhead cost.

Example are :

  1. Rent on land and factory building.
  2. Interest on the investment of fixed capital.
  3. Insurance charges.
  4. Property Tax.
  5. Maintenance cost variable.
  6. Salary of permanent employees.
  7. Normal profits.

SHAPE OF FIXED COST CURVE

The shape of TFC curve is straight line parallel to x-axis. This is because cost remain constant over all units of output that are produced.

TFC Schedule  
Output TVC
0 100
1 100
2 100
3 100
4 100
5 100

 

TOTAL COST

Total cost of the firm is the expenditure it incurres in the production of given level of output.

Total cost of the sum of TFC and TVC. Since TFC is constant and TVC increases as the output increases, so TC also increases as the total variable cost increase.

With the further increase in output, TC takes the shape of TVC.

SHAPE OF TC

The TC curve is derived from TVC and TFC. TC curve is obtained by adding TVC and TFC at each unit of output.

TC Schedule  
Output TVC TFC TC
0 0 100 100
1 15 100 115
2 20 100 120
3 24 100 124
4 27 100 127
5 29 100 129
6 32 100 132
7 36 100 136
8 41 100 141
9 47 100 147

 

(i)         TC curve starts from the point of TFC at zero level output (TC = TFC)

(ii)        TC arise due to change in TVC. Thus the TC curves takes the sharp of TVC.

(iii)       The vertical distance between TVC and TC curve at any given level of output gives TFC.

S. No. Basis Fixed Cost Variable Cost
1. Meaning It does not changes with changes in output It changes with the changes in output
2. Zero cost It can never be zero, even when the production is zero It can be zero when the production is zero
3. Factors of production This cost is incurred on the fixed factors of production e.g. land. This cost is incurred on the variable cost of production e.g. labour.

AVERAGE FIXED COST

AFC is the fixed cost of a firm incurrent per unit of output. It is the ratio of TFC and output produced.

AFC continuously falls as the output increases because TFC is constant at all the level of output.

TC Schedule  
Output TFC
0 100
1 100 100
2 100 50
3 100 3333
4 100 25
5 100 20
6 100 16.66
7 100 14.28
8 100 12.5
9 100 11.11

 

SHAPE OF AFC

As output increases, the AFC curve falls continuously. For large value of output AFC curve bends towards x-axis but does not touch x-axis. The shape is Rectangular Hyperbola.

AVERAGE VARIABLE COST (AVC)

AVC of a firm is the variable cost incurred per unit of output. It is the ratio of TVC and output produced.

 

SHAPE OF AVC

AVC is a u-shaped curve because AVC first falls and than starts rising. The shape of AVC depends on Average product of a firm. AP of the firm first rises as the variable factor rises, as a result cost per unit of as the variable factor falls. When AP starts falling AVC is rising when AP is maximum AVC is minimum.

 

AVERAGE TOTAL COST OR AVERAGE COST

ATC or AC of a firm is the cost incurred per unit of output. It is the ratio of TC to the output produced. It is also the sum up of AFC and AVC.

SHAPE OF AC CURVE

AC is the u-shaped curve. This implies that as output increases, ATC or AC first falls and than starts rising.

 

 

Relationship between ATC, AVC and AFC

Q.1.     How AC is derived from AFC and AVC.       

1.         Up to Q1level of output, both AFC and AVC are             falling therefore AC curve slopes downward.

2.         In between the output range. Q1 and Q2 level, AFC continues to fall but AVC starts rising. AC continues to fall. AC curve reaches the min. point after the min. point of AVC curve. This is because fall in AFC is much higher than the rise in AVC.

3.         In between the output level, Q2 and Q3, the fall in AFC is much lesser than the rise in AVC. Now the AC will start rising.

4.         The curve AC and AVC continues to come closer but they never intersect as AFC never becomes zero.

 

MARGINAL COST

Marginal cost of a firm is the additional cost it incurs when one more unit of output is produced.

TVCn – TVCn – 1

SHAPE OF MC

The marginal cost curve is also a u-shaped curve. It reflects the change in TC and TVC. The u-shaped of MC curve also depends on the law of variable proportion.

In the first stage of increasing returns to factors. TVC rises at diminishing rate which implies that change in TVC (MC) goes on falling initially. In the second stage of decreasing returns to factors, TVC rises at increasing rate i.e. change in TVC (MC) rises.

 

Relationship between AC, MC and AVC

            AC and MC :

1.         When MC is falling remains below AC. This leads to fall in AC.

2.         When MC starts rising but remains below AC, AC continues to fall.

3.         AC = MC at the min point of AC and AC is constant.

4.         When MC rises and is greater than AC. This leads to rises in AC.

AVC and MC :

  1. When MC is falling and is less than AVC, this leads AVC to fall.
  2. When MC rises but continues to remain below AVC, this leads AVC to fall.
  3. AVC = MC at the min point of AVC.
Q.2.     Can AC falls, when MC is rising?

Ans.     Yes MC can rise, even when AC is falling. This can be seen from the output range between Q1 to Q2, where MC has started rising but AC is still falling to reach the optimum capacity.

 

 

 

Relationship between TC and MC

1.         When TC rise at a diminishing rate MC, falls.

2.         When TC become constants, MC reaches the min. point.

3.         When TC rise at an increasing rage, MC starts rising.

4.         MC can be derived from the total cost.

 

 

 

CONCEPT OF REVENUE

The money receipt from the sale of the product is revenue. The 3 terms used in the revenue concept are :

Total Revenue :

            Total revenue (TR) refers to the total amount of money received by the firm from the sale of the product. It is calculate by multiplying price/unit of the commodity with the quantity of output sold.

Average Revenue :

            Average revenue is the revenue per unit of the commodity sold. Average revenue means the price of the commodity. It is calculate by dividing total revenue by the quantity

Marginal Revenue :

            Marginal revenue is the net addition to the total revenue when one more unit of the commodity is sold.

The commodity is sold

Relationship between TR, MR and AR

(1)        When AR Changes :

Quantity sold Price unit TR MR
1 10 10 10
2 9 18 8
3 8 24 8
4 7 28 4
5 6 30 2
6 5 30 0
7 4 28 -2

 

Relationship :

  1. TR increases and keeps on rising till MR is positive.
  2. When MR is zero, total revenue is maximum.
  3. When MR becomes negative TR starts falling.
  4. When both AR and MR are falling MR falling at a greater rate than AR.

(2)        When AR is Constant :        

When AR is constant, MR is also constant and equals to it. It will take a shape of horizontal line parallel to x-axis and both the curves will coincide TR will continuously rises with a constant  slope.

 

 

EXERCISE

Multiple Choice Questions

  1. The curve which is inversely S-shaped is

(a) TFC                                              (b) TVC

(c) MC                                                (d) AVC

  1. Which cost is not affected by fixed cost

          (a) MC                                               (b) AC

(c) TC                                                 (d) None of these

  1. Marginal cost refers to net addition to the total cost when one more unit of the output is _____________

          (a) Consumed                                    (b) Produced

(c) Sold                                              (d) Employed

  1. Average fixed cost is

          (a) Rectangular hyperbola                 (b) Inverse U-shaped

(c) U-shaped                                      (d) Inverse S-shaped

  1. Normal profits earned by a firm are indicated by

          (a) Implicit cost                                  (b) Explicit cost

(c) Fixed cost                                     (d) Variable cost

  1. The curve starting from Y-axis and inversely S-shaped is

          (a) TVC curve                                     (b) MC curve

(c) TC curve                                       (d) AC curve

  1. When AC is rising, MC is

          (a) Less than AC                                (b) More than AC

(c) Equal to AC                                  (d) Constant

  1. Fixed cost is also known as

          (a) Supplementary cost                      (b) Prime cost

(c) Average cost                                  (d) Explicit cost

  1. Variable cost is also known as

          (a) Supplementary cost                      (b) Prime cost

(c) Overhead cost                               (d) Explicit cost

  1. When AC is falling, MC is always

(a) Falling                                          (b) Rising

(c) Below AC                                      (d) Above AC

  1. When MC is falling

(a) TC is rising at increasing rate       (b) AC is rising

(c) AC is below MC                            (d) TC is rising at diminishing rate

  1. When prices are constant

(a) MR is falling                                 (B) MR is vertical

(c) MR is horizontal                           (d) MR is rising

  1. MR is

(a) Revenue from last unit of output sold

(b) Net addition to total revenue

(c) TRn – TRn – 1

(d) All of the above

  1. Which statement is incorrect about TVC

(a) TVC is zero at zero level of output

(b) TVC is inverse S-shaped curve

(c) TVC always rises with rise in output

(d) TVC = TC + TFC

  1. Explicit cost + Implicit cost gives

(a) Accounting cost                            (b) Variable cost

(c) Economic cost                               (d) None of the above

  1. MC is U-shaped because of

(a) Returns to scale                            (b) Returns to factor

(c) Both (a) & (b)                                (d) None of these

  1. When TR is maximum

(a) MR is positive                               (b) MR is negative

(c) MR is zero                                     (d) None of these

  1. Profits of the firm are equal to

(a) Revenue                                        (b) Revenue – cost

(c) Cost – Revenue                             (c) Cost + Revenue

  1. Which the following is variable cost

(a) Interest on loan                            (b) Monthly rent

(c) Insurance Premium                      (d) Wages to employees

  1. When AVC rises, and AFC false at greater rate than rise in AVC, AC will

(a) Rise                                              (b) Fall

(c) Constant                                       (d) No effect

  1. AC = MC, at

(a) Minimum point of AC                   (b) Minimum point of MC

(c) Minimum point of AVC                 (d) None of these

 

  1. Which statement is incorrect about AVC

(a)                                     (b) AVC is U-shaped

(c) AVC = AC + AFC

(d) It is variable cost per unit of output

 

Answer  Key

1 2 3 4 5 6 7 8 9 10
B A B A   C B A B C
11 12 13 14 15 16 17 18 19 20
D C D D C B   B D B
21 22                
A C                

 

Numerical Questions

  1. A firm Average Fixed Cost of producing 2 units of a good is ` 9 and given below is its total cost schedule. Calculate its Average Variable Cost and Marginal Cost for each of the given level of output.
Output (units) Total Cost (`)
1 23
2 27
3 30
  1. Complete the following table :
Output (units) Price (`) Marginal Revenue Total Revenue
1 10
2 9
3 24
4 4

 

  1. Calculate total variable cost and total cost from the following cost schedule of a firm whose fixed cost is ` 10.
Output 1 2 3 4
MC (`) 6 5 4 6
  1. Find the maximum profit position of a producer by comparing TC and TR on the basis of the following data :
Output AR AC
1 12 7
2 11 9
3 10 10
4 9 11
5 8 12
  1. The total fixed cost of a firm is `12. Given below is its marginal cost schedule. Calculate total cost and average variable cost for each given level of output.
Output (units) 1 2 3 4
MC (`) 9 7 2 4

 

  1. Complete the following table :
Variable input TPP APP MPP
0 0
1 20
2 26
3 66

 

  1. Given below is the cost schedule of a firm. Its total fixed cost is ` 100. Calculate average variable cost and marginal cost at each given level of output.
Output (units) 1 2 3 4
Total cost (`) 350 450 610 820

 

  1. Calculate total variable cost and marginal cost at each given level of output from the following table :
Output (units) 0 1 2 3 4
Total cost (`) 40 60 78 97 124

 

  1. Complete the following table :
Price (`) Output (Units) TR (`) MR (`)
7 7
2 10
3 (-1) 1
1 (-5) 5

 

  1. Complete the following table :
Output (units) Total Cost (`) Average Variable Cost (`) Marginal Cost (`)
0 80
1 180
2 270
3 350
4 440

 

  1. Total fixed cost of a firm is `12 given below is the marginal cost schedule of a firm. Calculate total cost and AVC from the following :
Output (units) 1 2 3 4 5 6
MC (`) 9 7 2 4 8 12

 

  1. Complete the following table :
Output TC TFC TVC MC
0 20
1 30
2 50

 

  1. Fixed cost of a firm is `30. Calculate AC and MC at each given level of output.
Output 1 2 3 4
TVC 20 38 60 86

 

  1. Complete the following table :
Output AR MR TR
1 30
2 52
3 22
4 6

 

  1. A firm total fixed cost is `60. Calculate ATC and MC
Output 1 2 3
AVC 20 25 24

 

  1. From the following data calculate AVC and MC.
Output 0 1 2 3
TC 60 100 130 150

 

  1. Calculate TP and NP
Labour 1 2 3 4 5 6
AP 2 3 4 4.25 3 3.5

 

  1. Complete the following table when each unit of a commodity can be sold at `5.
Output TR AR MR
1
2
3
4
5
6
7

 

  1. Following information is given about the firm
Output 0 1 2 3 4 5 6
TC 20 25 28 30 36 45 60

Find out  :

(a) AFC of producing 4 units             (b) AVC of producing 5 units

(c) MC of producing 3rd unit              (d) AC of producing 6 units

 

  1. From the following data, calculate firm’s break even level of output if TFC is `25. Also calculate firm’s profit maximizing output using TR-TC approach.
Output 0 1 2 3 4 5 6
MC 30 12 8 2 5 9
TR 30 55 75 90 100 105

 

  1. From the following table calculate the firm’s break even level of output and profit maximizing output using TR-TC approach. TFC is `10.
Output 0 1 2 3 4 5 6
MC 15 10 4 2 5 10
TR 20 15 12 10 5 3
  1. Using MC-MR approach/find out profit maximizing level of output.
Output Price ATC
7 20 4
8 19 5
9 18 6
10 17 7
  1. Given below is a cost schedule of a firm. Its AFC is `20 when it produces 3 units of output.
Output 1 2 3
AVC 20 28 32
  1. Complete the following table
Output ATC AVC MC
1 54 30 30
2 24
3 24
4 33
  1. A firm’s fixed cost is `2000. Compute TVC, TC, AVC, ATC.
Output 1 2 3 4 5 6 7
MC 2000 1500 1200 1500 2000 2700 3580
  1. On the basis of the info. Given below determine the level of output at which the producer will be at equilibrium. Use MC-MR approach. Give reasons for your answer :
Output AR TC
1 7 7
2 7 15
3 7 22
4 7 28
5 7 33
4 7 28
4 7 28
  1. Given below is a cost schedule of the firm. Its TFC is `150. Calculate AVC and MC.
Output 1 2 3 4
TC 300 400 560 770

 

  1. Complete
Price or AR Units sold TR MR
10 100
11 9
12 96
13 7

 

  1. Complete
Output AFC TFC TVC MC
0
1 10
2 50 18
4 20

 

  1. Calculate TC and AVC for each level of output.
Output AFC MC
1 60 32
2 30 33
3 20 28
4 15 30
5 12 35
6 10 43

 

  1. Find profit maximizing level of output.
Output Price ATC
7 20 12
8 18 10
9 16 12
10 14 14
  1. Find profit maximizing level of output
Output (units) 1 2 3 4
MR 6 4 2 0

 

 

  1. Calculate TC and AVC for each level of output.
Units of Variable factor Average product
1 20
2 24
3 28
4 29
5 28
  1. Complete
Output AC AFC AVC MC
1 100 40
2 36
3 36
4 15 36
5 12 41

 

  1. Complete the following table if AFC at one unit of output is `60.
Output 1 2 3 4 5 6 7 8
TC

TVC

TFC

AVC

AFC

ATC

MC

90 105 115 120 135 160 200 260

 

  1. Complete :
Output 0 1 2 3
TVC

AVC

MC

  20 25 28

 

  1. From the given data calculate MC
Output 1 2 3 4
AVC 60 40 30 26.25

 

 

  1. Complete the following table
Output TVC AVC MC
1 10
8 6
3 27
10 13

 

  1. From the following table calculate TC and AVC.
Output 1 2 3 4 5 6
AFC 60 30 20 15 12 10
MC 32 30 28 30 35 43

 

  1. Complete the following data
Output AFC MC TC
1
2 10 82
3 20 8
4 99
5 12 10

 

1 Mark

 

  1. What does cost mean in economies?
  2. If the firm is witnessing increasing returns to of factors, what will happen to total cost?
  3. Why are TVC and TC curve are parallel to each other?
  4. What is the value of total cost at a output zero, if TFC is Rs. 20.
  5. Is the rent paid on water meter is fixed or variable cost?
  6. Is the cost of row martial paid fixed or variable cost?
  7. At what point does the MC curve cuts the AC curve?
  8. Express ATC in term of AFC and AVC.
  9. Draw TC, TVC and TFC curve in the same diagram?
  10. Draw AC, AVC and AFC curve in the same diagram?
  11. Why is ATC greater than AVC?
  12. Why is AFC behave, when output is increased.
  13. Do ATC and ACV curve intersects? Give reason.
  14. What does AFC curve look like? Why does it look so?
  15. The AC of producing 5 units is Rs. 6 and that of producing 6 units is Rs. 5. What is MC of producing 6 units.
  16. Can the AC be more than the MC, when AC is falling?
  17. Output increase from 3 units to 4 units as result, TC rise from Rs. 19.6 to Rs.24.5. calculate MC.
  18. What is the difference between TC and TVC calls?
  19. What will happen to ATC, when MC > ATC.
  20. What will happen to ATC, when MC = ATC.
  21. When AC is rising what is the relation between AC and MC.
  22. At what point MC curve cuts AVC curve?
  23. Why is MC curve u-shaped.
  24. Classify the following in to fixed and variable cost

(a)      Wages to daily workers

(b)      Expenditure in row material

(c)      excise duty

(d)      sales tax.

 

 

3-4 Marks

  1. What are total fixed cost, total variable cost and total cost curve? How are they derived?
  2. Distinguish between fixed and variable cost giving example?
  3. Why MC curve in the short run u-shaped?
  4. Explain the relationship between MC and AC with the help of cost schedule and diagram?
  5. What changes will take place in AC when MC is rising?
  6. Why AC curve in the short run u-shaped?
  7. What does fixed variable, determines MC give reasons.
  8. Draw TFC and AFC curve explain with diagram.
  9. Can AFC be zero? Give reason.
  10. Why does the gap between ATC and AVC reduces.
  11. TC is not the sum total of MC?Why?
  12. State true or false.

(a)      ATC is its minimum point. When MC is at its minimum.

(b)      Since TFC does not change, so AFC is constant.

(c)      ATC is falling so long as MC is falling.

(d)      As long as MC is rising. ATC is rising.

(e)      At an output of one unit, ATC is equal to MC.

  1. Using diagram, explain the relationship between TC and MC.
  2. Explain the u-shape of ATC curve?

 

 

IMPORTANT QUESTIONS (REVENUE)

  1. What is the relationship between TR, price and quantity sold?
  2. What is the relationship between AR and MR, when AR is constant.
  3. When TR falls, what happens to MR?
  4. How does TR behaves, when MR falls but positive?
  5. How does TR behave when MR is negative?
  6. When is MR curve below the AR curve?
  7. What changes should be taken in total revenue so that (a) MR is positive and constant (b) MR is positive and falling.
  8. What changes will take place in MR, when (a) TR increase at increasing rate.
  9. Define MR? What happens to AR, when MR is (a) less than AR (b) Equal to AR.
  10. What changes in TR, will result in (a) a decrease is MR (b) an increase in MR.
  11. What will be the shape of demand (AR) curve, so that TR curve is (a) Positively sloped straight line passing through the origin (b) horizontal line.

TRUE OR FALSE (give reasons)

  1. Average variable cost can fall even when marginal cost is rising.
  2. The difference between total cost and total variable cost falls with increase in output.
  3. Average cost can rise even when marginal cost is falling.
  4. Average variable cost falls when it is more than marginal cost.
  5. The minimum point of average cost curve lies to the right of average variable cost curve?
  6. Average cost and average variable cost curves coincide when average fixed cost is zero.
  7. Total fixed cost is more than total variable cost at zero level of output.
  8. Total cost can be obtained as summation of marginal costs.
  9. Total cost of production is the sum total of variable cost and marginal cost.
  10. If 10 units cost Rs. 36 to produce and 12 units cost Rs. 50, then marginal cost is equal to Rs. 14.
  11. Marginal cost is not affected by total fixed cost.
  12. The gap between average variable cost and average fixed cost falls with rise in output.
  13. Marginal cost changes at a rate faster than average cost.
  14. Average cost falls only when marginal cost falls.
  15. Cost that have been already incurred are important factors in making production decisions.
  16. The marginal cost curve can intersect the average cost curve at any point.
  17. Explicit cost includes opportunity cost of resources owned and used by the firm’s owners.
  18. When marginal cost rises, average cost will also rise.
  19. MC is minimum at point where TC start increasing at an increasing rate.
  20. Average cost must exceed marginal cost at the point when average cost is minimum.
  21. The MC curve may be rising or falling before it becomes equal to AVC and ATC curves.
  22. All per unit cost curves (i.e. AC, AVC and AFC curves) are U-shaped.

 

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