Question

Write the meaning of Production Cost. Explain Average cost with the help of a diagram.

Hint:

Remember that the Marginal Cost (MC) curve always intersects the Average Cost (AC) and Average Variable Cost (AVC) curves at their respective minimum points.

Answer 1

Step 1: Meaning of Production Cost:
Production Cost refers to the total expenditure incurred by a firm in the process of producing a certain level of output. It includes all the payments made to the factors of production (like wages to labor, rent for land, interest on capital) and on non-factor inputs (like raw materials, fuel, power).
Costs are generally divided into two types: \begin{itemize} \item Explicit Costs: Direct, out-of-pocket payments made by a firm for inputs, such as wages, rent, and raw material costs. \item Implicit Costs: The imputed value of the inputs owned and used by the firm in its own production process, such as the salary the owner could have earned elsewhere. \end{itemize} Total Production Cost = Explicit Costs + Implicit Costs.

Step 2: Explanation of Average Cost:
Average Cost (AC), also known as Average Total Cost (ATC), is the per-unit cost of production. It is calculated by dividing the Total Cost (TC) by the total quantity of output (Q) produced. \[ AC = \frac{TC}{Q} \] Average cost is the sum of Average Fixed Cost (AFC) and Average Variable Cost (AVC). \[ AC = AFC + AVC \] \begin{itemize} \item AFC (\(TFC/Q\)) continuously falls as output increases. \item AVC (\(TVC/Q\)) first falls, reaches a minimum, and then rises due to the law of variable proportions. \end{itemize} The Average Cost curve is typically U-shaped. It falls initially because of increasing returns and economies of scale. After reaching a minimum point, it starts to rise because of diminishing returns and diseconomies of scale. The initial fall in AC is due to the fall in both AFC and AVC. The eventual rise in AC is because the sharp rise in AVC outweighs the continuous fall in AFC.

Step 3: Explanation with Diagram:
\begin{center} \begin{tikzpicture}[scale=0.9] \draw[->] (0,0) -- (7,0) node[right] {Output (Q)}; \draw[->] (0,0) -- (0,5) node[above] {Cost}; \draw[thick, color=red, domain=0.5:6] plot (\x, {2.5/\x}) node[right] {AFC}; \draw[thick, color=green] (1,3) .. controls (2.5,1) and (3.5,1.2) .. (6,4) node[right] {AVC}; \draw[thick, color=blue] (1,4.5) .. controls (3,1.8) and (4.5,2) .. (6,4.5) node[right] {AC}; \draw[thick, color=purple, domain=1:6] plot (\x, {0.2*(\x-3.5)^2 + 1.5}) node[right] {MC}; \end{tikzpicture} \end{center} In the diagram: \begin{itemize} \item The Y-axis represents Cost and the X-axis represents Output. \item The AC curve is shown in blue. It is U-shaped, first decreasing, reaching a minimum, and then increasing. \item The shape of the AC curve is a result of its components: the continuously falling AFC curve (red) and the U-shaped AVC curve (green). \item The Marginal Cost (MC) curve (purple) is also shown, which cuts the AC curve at its lowest point. \end{itemize}

Step 4: Final Answer:
Production cost is the total expenditure on inputs for production. Average cost is the per-unit cost of production (TC/Q). The AC curve is U-shaped because it initially falls due to economies of scale and then rises due to diseconomies of scale.