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(B) Numerical Example: In Cost Analysis, mainly marginal costs and average costs, which are among other variants of cost, need to be studied. Average costs are of three types: average total cost, average fixed cost and average variable cost. We will begin with marginal cost and then proceed to average costs.

i) Marginal cost: Let us assume that fixed costs are of the value of $40. This amount will remain constant throughout the act of production. Let the variable cost be $10 per unit. As the variable units go on increasing this cost will continuously increase as a multiple of 10.

 

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I II III IV V VI
Production Fixed Cost Variable Marginal Total Marginal Cost
Units  Cost Output Cost II + III (MVC ? M output)
1 40 - - 40 -
2 40 10 4 50 DMC 2.5 (10 ? 4)
3 40 20 7 60   1.42 (10 ? 7)
4 40 30 7 70 CMC 1.42 (10 ? 7)
5 40 40 5 80   2.00 (10 ? 5)
6 40 50 2 90 IMC 5.00 (10 ? 2)
7 40 60 1 100   10.00 (10 ? 1)

Column I shows the Units of Production. In column II we have $40 as Fixed Cost. This remains constant throughout the act of production. Column III explains Variable Cost of production at the rate of $10 per unit of variable inputs. In column IV Marginal Output changes have been shown from our earlier example. In column V we find Total Cost as a sum of fixed and variable costs. Column VI has the Marginal Cost per unit of output produced. This is a ratio of marginal or additional variable cost (which is 10) divided by marginal units of output produced. Accordingly marginal cost is 10 ¸ 4 = 2.5, 10 ¸ 7 = 1.42 …etc.

Marginal cost behavior shows three phases of change. Initially from 2 units of production to 3 units of production the marginal cost decreases from 2.5 to 1.42. Then between 3 to 4 units of production it remains constant. Finally, from unit 4 onwards marginal cost continuously increases from 1.42 to 10. The three phases marked as DMC, CMC and IMC exactly correspond with IMR CMR and DMR on the output or returns side. As we have seen earlier, where returns diminish, costs increase and both are constant for the same units of output.

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Index

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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