In the previous chapter, we examined the production process where a producer uses different factor inputs to produce goods. In this chapter, we will explain the relationship between cost and output. We aslo define the cost of production, identify various types of costs and analyze short run cost.
Definition of Cost of Production:
By "Cost of Production" is meant the total sum of money required for the production of a specific quantity of output. In the word of Gulhrie and Wallace. "In Economics, cost of production has a special meaning. It is all of the payments or expenditures necessary to obtain the factors of production of land, labor, capital and management required to produce a commodity. It represents money costs which we want to incur in order to acquire the factors of production". In the words of Campbell, "Production costs are those which must be received by resource owners in order to assume that they will continue to supply them in a particular time of production".
Elements of Cost of Production:
The following elements are included in the cost of production:
(a) Purchase of raw machinery, (b) installation of plant and machinery, (c) Wages of labor, (d) Rent of Building, (e) Interest on capital, (f) Wear and tear of the machinery and building, (g) Advertisement expenses, (h) Insurance charges, (i) Payment of taxes, (j) In the cost of production, the imputed value of the factor of production owned by the firm itself is also added, (k) The normal profit of the entrepreneur is also included In the cost of production.
Family of Costs in the Short Run:
The total cost of a firm in the short run is divided into two categories (1) Fixed cost and (2) Variable cost. The two types of economic costs are now discussed in brief.
(1) Total Fixed Cost (TFC):
Total Fixed cost occur only in the short run. Total Fixed cost as the name implies is the cost of the firm's fixed resources, Fixed cost remains the same in the short run regardless of how many units of output are produced. We can say that fixed cost of a firm is that part of total cost which does not vary with changes in output per period of time. Fixed cost is to be incurred even if the output of the firm is zero. For example, the firm's resources which remain fixed in the short run are building, machinery and even staff employed on contract for work over a particular period.
(2) Total Variable Cost (TVC):
Total variable cost as the name signifies is the cost of variable resources of a firm that are used along with the firm's existing fixed resources. Total variable cost is linked with the level of output. When output is zero, variable cost is zero. When output increases, variable cost also increases and it decreases with the decrease in output. So any resource which can be varied to increase or decrease with the rate of output is variable cost of the firm. For example, wages paid to the labor engaged in production, prices of raw material which a firm. incurs on the production of output are variable costs. A firm can reduce its variable cost by lowering output but it cannot decrease its fixed cost. These expenses remain fixed in the short run. In the long run there are no fixed resources. All resources are variable. Therefore, a firm has no fixed cost in the long run. All long run costs are variable costs.
(3) Total Cost (TC):
Total cost is the &um of fixed cost and variable cost incurred at each level of output. Total cost of production of a firm equals its fixed cost plus its:
TC = TFC + TVC
Where: TC = Total cost; TFC = Total fixed cost and TVC = Total variable cost.
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