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

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

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

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

"Long-run marginal cost curve is that which shows the extra cost incurred in producing one more unit of output when all inputs can be changed." - Robert Awh

• "In the long-run, all the factors of production are assumed to be variable." - Koutsoyiannis
• "It will be helpful to think of the long run situation into any one in which the firm can move." - Leftwich

"The long run total cost of production is the least possible cost of producing any given level of output when all inputs are variable." - Libhafasky

"The long run average cost curve shows the lowest average cost of producing output when all inputs can be varied freely." - Robert Awh

Long-run costs: Costs when a firm can change all inputs, including scale/plant size.

Short-run costs: Costs when a firm can change only some inputs (like labor), but not its scale/plant size.

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

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

Where:

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

Or, more generally:

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

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

• 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.

• 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.

• 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.

• 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.

• 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).

• In the long run, firms can change all production factors for least cost.
• LAC curve helps in selecting the best way to produce for each output.
• LMC tells us how much extra cost is needed to raise output by one unit.
• Understanding cost curves helps firms plan profitably for both present and future production.​

• Short-run: Both fixed and variable costs; a given plant size.
• Long-run: Only variable costs; plant size can be changed for the cheapest production.
• Both average cost curves are U-shaped but due to different economic reasons.

• Short-run cost function splits costs into fixed & variable.
• Fixed costs do not change with output. Variable costs do.
• Graphs and tables make these concepts easier to remember.

• 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.

• 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.

• 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.

• 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.

• AR and MR stay constant at the level of market price for every output.
• TR increases in direct proportion to output (straight line upward).
• In perfect competition, firms are price takers, not price makers.
• Both curves (AR and MR) are flat and coincide.
• At zero output, TR is zero.

• TR peaks then may fall at higher output.
• AR is the price per unit; it always drops.
• MR is below AR; it can become zero or negative.
• MR drops at double the rate of AR if the AR curve is a straight line.
• Tables and curves show how income changes in imperfect competition.

• 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.

• Under perfect competition, AR = MR = Price; both are horizontal, and TR rises at a constant rate.
• Under monopoly with constant TR, AR is a rectangular hyperbola and MR = 0 along the X‑axis.
• Under imperfect competition, AR slopes downward, MR lies below AR, and TR rises at a diminishing rate, becomes maximum when MR = 0, then falls.
• Under oligopoly with kinked demand, AR has a kink and MR is discontinuous; prices become sticky around the kink.

• 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.