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9.4 Cost Analysis

(A) Behavior of costs: Cost of production is a function of the volume of output produced. Total cost is made up of two components. Some of the inputs are fixed and indivisible. Their aggregate cost remains constant and hence goes on falling in an average proportion as output increases. Other factors of production are variable and go on increasing with the level of output produced. Hence the variable cost of production continuously increases but in different proportions. The behavior of the total cost of production is a mixture of these two influences. Like the law of returns there are similar laws for cost behavior. The cost behaves exactly in an opposite manner as compared to the behavior of the returns or the output. If input worth $1 produces 3 units of output, then per unit of good, cost of production is 33 cents. If output produced decreases to 2 units per dollar, cost increases to 50 cents per unit and if the output produced increases to 4 units per dollar, cost decreases to 25 cents per unit of output.


Cost of Input Output Produced Cost per Unit
$1 2 50 cents
$1 3 33 cents
$1 4 25 cents


The phase of Increasing Marginal Returns corresponds with Diminishing Marginal Cost. The Diminishing Marginal Returns phase corresponds with Increasing Marginal Cost and Constant Marginal Returns are equivalent to Constant Marginal Cost. This is diagrammatically represented as-

    Returns Behavior          Costs Behavior

           IMR                  ®       DMC

          CMR                  ®       CMC

           DMR                 ®       IMC


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9.1 - Concept of a Firm
9.2 - Factors of Production and Product Output
9.3 - Costs and Profits
9.4 - Costs Analysis

Chapter 10

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