RELATIONSHIP BETWEEN THE VARIOUS TYPES OF COSTS

Relationship between TFC, TVC and TC

The diagram, figure 8, given below shows the graphical relationship between TC, TFC and TVC.

TVC curve lies below TC curve because the former is a part of the latter as revealed in this equation: TC = TFC + TVC.

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The distance between them is constant; and it is equal to TFC. TVC curve intersects (cuts) TFC curve because the latter is parallel to the base, while the former takes its origin from zero and it gradually swings upward until it intersects TFC from below at point A and it rises above it as shown in figure 8.

 

Relationship between average curves (ATC, AFC and AVC) and MC

  1. The above diagram, figure 9, shows graphical relationship between ATC, AFC, AVC and MC. AFC curve slopes downward from left to right; and it lies above MC and AVC but below ATC when it is falling. But it lies below all of them when others are rising.
  2. All the AC curves including MC curve slope downward during increasing returns or when they falling. And all swing up during decreasing returns or when they are rising, except AFC which continuously fall.
  3. MC curve lies below them during the period of increasing return; i.e. when they are falling. And it lies above them when they are rising; i.e. in the period of decreasing returns.
  4. MC curve intersects (cuts) the ACs’ curves from below and at their minimum points.

 

Reasons for the above

MC curve lies below other AC curves when they are falling because MC falls faster or it is smaller than others during increasing returns; i.e. when they are falling. And its curve lies above theirs when they are rising as MC rises faster or it is higher than others when they are rising during diminishing returns, MC curve reaches its minimum point before others because it rises first before others as its value is larger than others during period of diminishing returns. Thus it intersects them from below and at their minimum points.

 

Other types of cost

Implicit cost versus Explicit cost

  1. Implicit cost: It is a cost of a productive asset (a factor of production) which a producer owns and uses in the course of production, but he does not pay for it.
  2. Explicit cost: It is the normal cost of production, e.g. cost of raw materials, salary, rent, etc which a firm incurs and directly pays for them to outsiders (their owners) either permanently or periodically, e.g. salary, rent, wages, etc.

 

Private cost versus Social cost

  1. Private cost: They are similar to explicit cost. They are cost which a firm incurs and it directly pays for them; e.g. rent, raw materials, salary, etc. An economist refers to it as ‘value of best alternative use of a factor of production which a firm uses’.
  2. Social costs: They are costs caused by firms but they fall on the shoulders of other people or the public, e.g. pollution of air and water, dumping of organic or chemical waste into streams from which people fetch drinking water or besides public roads, markets, etc.

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