Class 10 Economics

Introduction to Cost

The expenditure incurred on the factors of production during the production process is called cost. Such expenditure can generally be measured in monetary terms. Cost is divided into short-run cost and long-run cost based on the factors of production used. Short-run cost is further studied by dividing it into fixed cost and variable cost. In this chapter, we will study only short-run costs.

(A) Meaning of Cost

To produce the various goods and services we use in our daily lives — such as food, clothing, mobile phones, televisions, notebooks, pens, and so on — the factors of production are required. The major factors of production include land, capital, labour, and organisation, while supporting inputs such as raw materials, energy, communications, and transportation are also needed.

In the production process, land receives rent, capital receives interest, labour receives wages, and organisation receives profit as the reward for using those factors. Similarly, for using inputs such as raw materials, energy, communications, and transportation, their respective prices, fees, and charges must be paid. The total expenditure made on all these factors of production during the production process is called cost.

(B) Short-Run Cost and Cost Curves

In economics, the short run refers to a time period in which not all factors of production can be changed — some factors remain fixed while others are variable. The total expenditure incurred on both fixed and variable factors of production in this period is called short-run cost. For example, a farmer producing rice keeps the area of agricultural land constant (a fixed factor) while adjusting the amount of labour, seeds, and fertilisers (variable factors) as needed. The cost the farmer incurs while producing rice is called short-run cost, because land is used as a fixed factor and the others as variable factors. The expenditure on both types of factors is called short-run cost.

Under short-run cost, Total, Average, and Marginal costs are discussed below:

(i) Total Cost and Total Cost Curves

The total expenditure incurred in producing a given quantity of goods and services is called Total Cost. In the short run, this is the sum of all expenditure on every type of factor of production. Total Cost is studied by dividing it into the following two parts:

a. Total Fixed Cost (TFC): The expenditure incurred on fixed factors of production — such as land, capital (machinery and equipment), permanent labour, and management — is called fixed cost. Fixed cost remains unchanged throughout the production period. This cost does not change whether production increases or decreases. Even when output is zero, this cost must still be borne. For example, if a shoe-making firm rents a building for Rs. 1,00,000 per year, it must pay that rent whether it produces shoes or not. In this case, the building rent is a fixed cost for the firm.

b. Total Variable Cost (TVC): The expenditure incurred on variable factors of production — such as temporary labour, raw materials, water, electricity, transportation, and packaging — is called variable cost. This cost increases when the quantity of production increases and decreases when it falls. In other words, variable cost changes as the level of production changes. For example, if a shoe factory produces 50,000 pairs of shoes, the cost of raw materials, transportation, and packaging increases accordingly; if it produces only 5,000 pairs, variable cost also falls. When output is zero, this cost is nil. The TVC curve starts from the origin and rises to the upper right. However, since it does not increase at a uniform rate — first rising at a decreasing rate and then at an increasing rate — it takes the shape of an inverted English letter “S”.

c. Total Cost (TC): The sum of Total Fixed Cost and Total Variable Cost is the short-run Total Cost. It is expressed as:

Total Cost (TC) = Total Fixed Cost (TFC) + Total Variable Cost (TVC)
That is, $$TC = TFC + TVC$$

(ii) Average Cost and Average Cost Curves

The cost incurred in producing one unit of a good is called Average Cost. In the short run, average cost is studied by dividing it into the following three parts:

a. Average Fixed Cost (AFC): The quotient obtained by dividing Total Fixed Cost (TFC) by the quantity of output (Q) is called Average Fixed Cost. In other words, it is the fixed cost per unit of output. The formula is:

$$AFC = \frac{TFC}{Q}$$

b. Average Variable Cost (AVC): The quotient obtained by dividing Total Variable Cost (TVC) by the quantity of output (Q) is called Average Variable Cost. It is the variable cost per unit of output. It is calculated as:

$$AVC = \frac{TVC}{Q}$$

c. Average Total Cost (ATC or AC): The quotient obtained by dividing Total Cost (TC) by the quantity of output (Q) is called Average Total Cost. It is also the sum of Average Fixed Cost (AFC) and Average Variable Cost (AVC). Average Total Cost is also simply called Average Cost. It is calculated using the following formulas:

$$ATC = \frac{TC}{Q} \quad \text{or} \quad ATC = \frac{TFC}{Q} + \frac{TVC}{Q} \quad \text{or} \quad ATC = AFC + AVC$$

(iii) Marginal Cost and Marginal Cost Curve

The quotient obtained by dividing the change in Total Cost by the change in quantity of output is called Marginal Cost. In other words, the additional change in Total Cost that occurs when one extra unit of a good or service is produced is called Marginal Cost. It is calculated as follows:

$$MC = \frac{\Delta TC}{\Delta Q} \quad \text{or} \quad MC = \frac{TC_n – TC_{n-1}}{Q_n – Q_{n-1}}$$

where,
$TC_n$ = Total Cost of the succeeding unit
$TC_{n-1}$ = Total Cost of the preceding unit
$Q_n$ = Succeeding quantity
$Q_{n-1}$ = Preceding quantity