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Revision: Microeconomic Theory >> Cost and Revenue Economics ISC (Commerce) Class 12 CISCE

Definitions [4]

Definition: Fixed Cost

"Fixed costs are costs which do not change with change in the quantity of output." — Anatol Murad

Definition: Variable Cost

"Variable cost is that part of total cost which varies directly with output." — McConnell

Definition: Total Cost

"Total cost of production is the sum of all expenditure incurred in producing a given volume of output." — Dooley

Define fixed cost. Give an example.

Fixed costs are the sum of total expenditure incurred by the producer on the purchase or hiring of fixed factors of production such as cost of plant and machinery.

Fixed cost is the cost which is incurred on buying fixed factors of production. It does not vary with the level of output.

Formulae [2]

Formula: Total Cost

(TC = Total Cost, FC = Fixed Cost, VC = Variable Cost)

Marginal Cost Formula

\[MC_n=TC_n-TC_{n-1}\]

Where:

: Marginal cost of nth unit
: Total cost at n units
TC_n−1: Total cost at (n-1) units

Or, more generally:

\[MC=\frac{\Delta TC}{\Delta Q}\]

: Change in total cost
: Change in quantity of output (usually 1 unit)

Key Points

Key Points: Cost of Production

Cost of production is key for production and pricing decisions.
Real cost includes broader sacrifices, while expenses are monetary payments.
Cost increases with output, and firms use this to optimise production levels.

Key Points: Cost Concepts > Total Costs

Fixed costs remain constant at any output level.
Variable costs change as output changes.
Total cost equals the sum of fixed and variable costs.
Average fixed cost (AFC) drops as output increases because FC is spread over more units.

Key Points: Theories of Costs: Traditional Theory of Costs/Short Run Cost Curves

There are two main cost theories: traditional and modern.
The three main types of cost in production are total cost, average cost, and marginal cost.
Marginal cost helps businesses decide if it is worth making more items.

Key Points: Cost Concepts > Average Cost

AC = TC/Q, or AC = AFC + AVC.
AFC always falls with more output; ATC and AVC form U-shaped curves.
Lowest ATC means most efficient production point.
The gap between ATC and AVC shrinks as AFC gets smaller.

Key Points: Cost Concepts > Marginal Cost

Marginal cost = extra cost for one extra unit.
MC uses only variable costs (not fixed cost).
MC curve is U-shaped in the short run.
MC is key for decision making: output is optimal when Marginal Cost = Marginal Revenue.
Sum of all MCs = Total Variable Cost (TVC).

Key Points: Relationship Between Average and Marginal Cost

AC is cost per unit; MC is cost of one extra unit of output.
Both AC and MC curves are generally U-shaped in the short run.
When MC lies below AC, AC falls; when MC lies above AC, AC rises.
MC cuts AC at the minimum point of the AC curve, from below.
The same relationship holds between MC and AVC.

Key Points: Long-Run Cost Curves

Long run = all inputs variable, no fixed cost, firm can change plant size and method of production.
LTC shows minimum total cost for each output in the long run.
It starts from origin, slopes upwards, and is inverse S-shaped.
It is formed as the envelope of STC curves.
LAC gives the lowest possible average cost for each output in the long run.
It is U-shaped and flatter than SAC.
It is the envelope curve of SACs and is used for long-run planning.
LMC measures the change in long-run total cost for one more unit.
Both LAC and LMC are U-shaped.
LMC cuts LAC at LAC’s minimum point.
U-shape of LAC is explained by economies (left side) and diseconomies (right side) of scale.
The minimum point of LAC is called the optimum point or optimum scale of production.

Key Points: Types of Revenue

TR is the total income from all units sold.
AR is revenue per unit and is equal to price, so the AR curve is the demand curve of the firm.
MR is extra revenue from selling one more unit.
When AR falls, MR also falls and is less than AR at each output level.
TR increases as long as MR is positive, is maximum when MR = 0, and falls when MR is negative.
MR can be positive, zero or negative, but AR (price) is normally always positive.

Key Points: Total Revenue

Total Revenue (TR) = total sales income of a firm.
Formula: TR = Price×Quantity.
Example: Price = ₹200, Quantity = 15 → TR = ₹3000.

Key Points: Average Revenue

Average Revenue (AR) = revenue per unit sold.
Formula: $AR=\frac{TR}{TQ}$
Example: TR = ₹3000, Quantity = 15 → AR = ₹200.

Key Points: Marginal Revenue

Extra revenue from selling one more unit
MR = Change in Total Revenue
Formula: MR = TRₙ − TRₙ₋₁
Example: ₹4200 − ₹4000 = ₹200

Key Points: Relation Between Total Revenue, Average Revenue, and Marginal Revenue

AR and MR are always calculated from TR.
If AR is flat, MR is also flat and equal—perfect competition.
If AR falls, MR falls at a faster rate—imperfect competition or monopoly.
If AR rises, MR is above AR, and both increase.
Diagrams clearly show differences in market competition.

Key Points: Relationship Between (Mutual Determination) AR, MR, and Elasticity of Demand

The firm’s AR curve is its demand curve; elasticity of demand is measured on this curve.
If $E > 1$ (elastic demand): MR is positive, and TR rises with more output.
If $E = 1$ (unit elastic): MR is zero and TR is maximum.
If $E < 1$ (inelastic): MR is negative and TR falls when output increases.

Key Points: Significance of Revenue Curve

Revenue curves (TR, AR, MR) help determine the equilibrium output and the profit or loss of a firm.
A profit‑maximising firm is in equilibrium where MR = MC.
If AR > AC → supernormal profit; AR = AC → normal profit; AR < AC → loss.
Full capacity is reached when AR is tangent to AC at the minimum point of AC (typical long‑run perfect competition).
In factor markets, AR and MR appear as ARP and MRP and help decide how many units of a factor to employ and what factor payment is appropriate.