Summary
A document containing the conceptual elements on Cost Theory is presented, which includes conceptual elements on: opportunity cost, application of opportunity cost, short and long-term costs, relationship of short and long-term costs with the function of production, average cost, marginal cost.
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- COST THEORY, OPPORTUNITY COST, SHORT AND LONG-TERM COST, PRODUCTION COST AND FUNCTION, MEDIUM COST, MARGINAL COST
OPPORTUNITY COST:
The opportunity cost to produce a good "X" is the quantity of good "Y" that must be sacrificed to produce a unit of good "x" ·; taking into account that both for "X" and for "Y" the use of a set of resources is assumed to produce a unit of any of them; and, the resources that are used in the production of good "X" cannot be used in the production of "Y". The opportunity cost is also known as the alternative cost.
APPLICATION OF OPPORTUNITY COST:
The opportunity cost is commonly used in managerial decision making, and it can be said that it is the quantifiable value of an opportunity overlooked to take another.
In other words, the opportunity cost is the amount or cost of labor, materials and / or manufacturing load that must be sacrificed in the production of an input X1, in favor of the production of another input X2, this concept is also known as the social cost of production.
EXAMPLE:
The RAS-KT company does not currently use 50% of the capacity of its warehouse: a manufacturer requests that idle capacity for 120,000 bolivars per year for rent, simultaneously presents the opportunity to participate in a new market, which would bring with it That an idle area of your warehouse should be occupied, so when carrying out the analysis to determine the convenience of expanding your company, you must take into account as part of the expansion cost the amount that you will stop receiving for not renting the warehouse:
| Variables | Bs. | Bs. |
| Expansion Sales | 1,300,000 | |
| Additional cost of expansion | ||
| - Raw material | 350,000 | |
| - Workforce | 150,000 | |
| - Miscellaneous expenses | 300,000 | |
| - Administrative expenses | 180,000 | |
| - Opportunity cost (annual rent) | 120,000 | |
| Total additional costs | 1,100,000 | |
| Opportunity Cost or Additional Profit | 200,000 |
In conclusion, the opportunity cost represents the utility derived from options that were rejected when making a decision…
SHORT AND LONG TERM COSTS:
Production costs directly depend on the time required to make adjustments to the quantities of productive factors; Due to the fact that the use of these factors can vary over time, and their use implies a cost, depending on the time each factor is used and the cost that this generates will vary the cost of production in the short or long term. Although, it should always be borne in mind that the long-term costs for a production volume will never be greater than the short-term costs for the same production volume.
To perceive the meaning of costs in the short and long term, it is convenient to review some principles, concepts and / or definitions; Among which are:
FIXED SUPPLIES:
They are those inputs of production, which cannot be increased or decreased rapidly, although market conditions indicate that their change would be productive. In reality, no input is absolutely fixed; However, they are considered fixed inputs, all those whose variation costs are so high that they cannot be changed immediately, of these can be mentioned among others: real estate and executive personnel of an organization.
VARIABLE INPUTS:
They are those inputs of production, whose quantity can be increased or decreased immediately when it is desired to vary the level of production; within these, among others, are: labor and raw materials.
SHORT TERM:
It is the period of time in which the input of one or more productive agents cannot be changed (it is fixed) regardless of the level of production; in such a way, that changes in the level of production must be obtained by changing only the level of employment on variable inputs.
LONG TERM:
It is a period of time long enough for all the productive factors to be fully adjusted; In this way, all the changes in the inputs are variable, being able to change even all of them until obtaining the most efficient combination of inputs for production.
PRODUCTION FUNCTION:
It is the mathematical function that indicates the maximum amount of product that can be obtained with a given set of inputs; in such a way, that the production function is the combination of the production possibilities; in this way, physical production is related to the inputs used for it.
LONG-TERM COSTS AND PRODUCTION FUNCTION:
Long-term costs are directly related to the expansion path of a production, because the latter indicates the volume or scale in which the company operates and how its long-term expansion of a route will be determined by the combination of the production possibilities (production function); In order to understand this relationship more easily, it is convenient to refer to the definition of expansion path, to then explain in detail how this relationship is determined (expansion path / total long-term cost).
SCALE LINE, PRODUCTION PATH OR EXPANSION ROUTE:
is defined by the isocline (points along which the marginal rate of technical substitution is constant) to the extent of which production increases when factor prices remain constant, it indicates how the proportions of the factors change when it alters production or expenditure and prices remain constant; consequently, this line joins all the possible equilibrium points if larger amounts of money are available (represented by the expansion path), because as one moves up it, the volume or scale in which the company operates increases.
RELATIONSHIP OF LONG-TERM COST AND PRODUCTION FUNCTION:
If different production functions are defined along an expansion path, each one of them determines different levels of production at different costs on the basis that these costs increase as production increases; in such a way, that for each equilibrium point (cut between the isoquant and the isocost) within the expansion path, a cost is produced for each production level, which can be represented by a function that relates the total cost to the total production for that level of expansion; this cost is the Total Long-Term Cost; in this way, the Long-Term Total Cost (CTL) function is equivalent to the scale line in terms of cost and production volume.
SHORT-TERM COSTS AND PRODUCTION FUNCTION:
If it is assumed that in the short term not all inputs can be varied, and if changes in production are required, variable resources must be modified to meet production needs, depending on the actual availability of the inputs. Fixed inputs to be modified in the different successive short terms according to the new projected production volume. In other words, if a new volume of production is projected in the short term, for which the variability of a fixed input is required (e.g.: machinery), the unavailability of this is compensated with the application of higher proportions of variable inputs (Eg: labor), until the quantity of the fixed input is available that allows reaching the expected production volume; In such a way,that as the amount of the necessary fixed input is increased in the short term, the application of the variable input that compensates for it is reduced, but always maintaining the same amounts of total production until equilibrium is reached. It is important to reflect that the shorter the term, the higher the cost of the volume of production due to the cost of the variation of the applied variable input.
To P; Tmst, C; cost, Q; quantity, of the initial production, y, p '; Tmst, C 'cost, Q' quantity, for the new production.
Given the graph, it can be seen that to achieve production with the increase in the fixed input, larger amounts of the variable input (labor) must be used, which increases the cost, until all the necessary fixed input is available. to reach the production level.
PRACTICAL APPLICATION OF SHORT AND LONG-TERM COSTS
The cost study function contributes proportionally to the increase in a company's profits, this objective is achieved by supplying the management with relevant figures that can be used for making decisions that reduce manufacturing costs or increase sales volume
The relationship between the amount of productive factors required: Labor (L), Capital (K), Land and Natural Resources (T) and Business Initiatives (H) and the amount of product that can be obtained is known as the production function.
Q = f (L, K, T, H)
It is important to emphasize that the elements that come into play in the cost of production of a good or service are direct materials, direct labor and indirect costs (Manufacturing Load), based on the above it can be concluded that the analysis of Cost is closely linked to production processes since many of the premises and variables arise from it that will allow to improve the costs of the production processes of an organization and consequently optimize its results.
Finally, it can be said that every production process must have a study or cost analysis function behind it, since this will allow it to take into account the convenience or not of producing an input or service (Opportunity Cost).
FIXED AND VARIABLE COSTS IN THE SHORT TERM:
To determine short-term costs, the type of input used in production and its associated cost must be specified, in the case of variable inputs, its determination is relatively simple, not being the case for fixed inputs, for which it is necessary to take into account the previous conceptions of fixed and variable inputs, in addition to reviewing certain definitions that are detailed below:
PRIVATE COST OF PRODUCTION:
It is what the businessman must pay to obtain the resources to be used in the production of a good and then sell it obtaining an economic benefit; In this way, there are the Explicit Cost and the Implicit Cost, which in their sum represent the economic benefit obtained by the employer.
EXPLICIT COST:
It is the cost that is used to acquire the resources of production; and, it has been the sum of the product of the quantities of production inputs used by their unit price.
IMPLIED COST:
It is a short-term fixed amount that is directly related to the valuation of the best alternative use of the time and money invested in production; which should be calculated based on the accounting cost-benefit ratio of production, based on the best alternative use of time and money used for production.
FIXED COST IN THE SHORT TERM:
The short-term fixed cost is the sum of the explicit short-term fixed costs and the implicit costs incurred by an entrepreneur.
VARIABLE COST IN THE SHORT TERM:
It is the sum of the amounts spent on each of the variable inputs used in production.
TOTAL COST IN THE SHORT TERM:
By definition, the total cost of production is the sum of the fixed cost and the variable cost that are used to obtain a volume of production; thus, CT = CF + CV; It is relevant to highlight that the level of use of inputs can vary depending on the level of production, therefore, variable costs must necessarily change; so that if the level of production is zero, so will its associated cost, and as the use of this input increases, its cost will also increase; while the fixed cost will always remain constant. If we graphically represent the variable and total fixed costs through a function that relates the quantities of products with their cost, it can be seen that the fixed cost (CF) is a line parallel to the axis of the abscissa,while the variable cost (CV) and the total cost (CT) are two curves whose slope is identical in all its points separated by the arithmetic variability represented by the constant value of the fixed cost; whose only difference between the two is its starting point on the ordinate axis, since while the variable cost starts from the origin, the total cost starts from the value corresponding to the fixed cost.
The following is the graph of the quantity / cost function in which the costs are represented: fixed, variable and total.
QUANTITIES
Therefore: The Total Variable Cost is equal to the product of the unit price of each variable input by the quantity of these inputs used in production; thus, CVT = P. Qv.
In short, the total cost in the short term is nothing other than the arithmetic sum of the Fixed Costs and the Variable Costs, in the short term, (CT = CF + CV).
Example:
| Production | Fixed cost | Variable cost | Total cost |
| one | 2,000 | 1,880 | 3,880 |
| two | 2,000 | 3,760 | 5,760 |
| 3 | 2,000 | 5,640 | 7,640 |
| 4 | 2,000 | 7,520 | 9,520 |
| 5 | 2,000 | 9,400 | 11,400 |
AVERAGE COST AND MARGINAL COST:
Analogously to the fixed, variable and total costs, for each of them there is an average cost; in addition, to establish the Marginal Cost. To understand in greater detail some definitions such as: Total Product, Average and Marginal; Each of them are defined below, starting with the basic definitions and continuing with the Medium and Marginal Costs:
TOTAL PRODUCT:
It is the Short-Term Production Function that relates the maximum total production obtainable in relation to the amount of variable input used (given the quantities of fixed input and production ingredients); therefore, the Total Product PT = Q; for Q: quantity of Product.
MEDIUM PRODUCT:
It is the ratio between the Total Product and the Quantity of variable Input used for production; thus, PM = Q / Qv
MARGINAL PRODUCT:
It is the addition to the total product attributable to the addition of a variable input unit in the production process, such that the marginal product has been, d Qv / d Q given the total product function f (x ¦ y); that is, PMg = Qv / Q.
AVERAGE FIXED COST:
It is the resulting ratio of the Average Fixed Cost and the number of Units produced; therefore, CFM = CFT / Q.
AVERAGE VARIABLE COST:
It is the resulting ratio of the Variable Cost and the number of Units produced; therefore: CVM = CVT / Q; otherwise, the CVM can be calculated based on the Average Product (PM) giving as a result that the Average Variable Cost and equal to the product of the Unit Price of the Variable Input by the inverse of the Average Product, taking into account that, the Cost Total variable is CVT = P. Qv; and if the second relation is the first, we obtain: CVM = P. Qv / Q; and knowing that PM = Q / Qv; then CVM = P. (1 PM).
AVERAGE TOTAL COST:
The Average Total cost is the resulting ratio between the Total Cost and the Number of Units produced; therefore CTM = CT / Q; otherwise, as the Total Cost is: CT = CV + CF, analogously the Total Average Cost can also be expressed as a function of the average fixed and variable, therefore CTM = CVM + CFM.
MARGINAL COST:
It is the addition to the total cost, attributable to an additional unit of production; therefore CMg = CTn-CTn-1; in such a way that as the Total Cost CT = CFT + CVT, and, CFT is always constant, the variation of the Marginal cost CMg will be given by the variation of CVT, so that CMg = CVT / Q. Analogously to the Average Cost, the Marginal Cost can also be expressed a function to Marginal Product; therefore, as CVT = P. Qv, and furthermore, CMg = P. Qv / Q, and, knowing that the marginal product is PM = Q / Qv, then CMg = P. (1 / PMg)
In short, the Average Cost: is the total cost divided by the total number of units produced or, in other words, it is the sum of the variable cost plus the fixed cost divided by the quantities produced.
CM = CT / Q = (CF + CV) / Q
Example:
| Production | Fixed cost | Variable cost | Total cost | Average cost |
| one | 2,000 | 1,880 | 3,880 | 3,880.00 |
| two | 2,000 | 3,760 | 5,760 | 2,880.00 |
| 3 | 2,000 | 5,640 | 7,640 | 2,546.67 |
| 4 | 2,000 | 7,520 | 9,520 | 2,380.00 |
| 5 | 2,000 | 9,400 | 11,400 | 2,280.00 |
The Marginal Cost: It is the increase in the total cost involved in producing one more unit, this is equivalent to the additional variable cost between the marginal production
CMg = (CV2 - CV1) / (Q2 - Q1)
Example:
| Production | Production
Marginal |
cost
Permanent |
cost
Variable |
Cost Var.
Additional |
cost
Marginal |
| 6 | 6 | 5.88 | 4.20 | 4.20 | 0.70 |
| 18 | 12 | 5.88 | 8.40 | 4.20 | 0.35 |
| 33 | fifteen | 5.88 | 12.60 | 4.20 | 0.28 |
| 40 | 7 | 5.88 | 16.80 | 4.20 | 0.60 |
| Four. Five | 5 | 5.88 | 21.00 | 4.20 | 0.84 |
| 48 | 3 | 5.88 | 25.20 | 4.20 | 1.40 |
| 49 | one | 5.88 | 29.40 | 4.20 | 4.20 |
Behavior of cost curves
SHORT-TERM COST CURVE: In the Short-Term Cost curve, the following are represented: CVM (Average Variable Cost), CFM (Average Fixed Cost), CTM (Average Total Cost) and CMg (Marginal Cost); Starting from its graphic representation, several relationships can be observed, which are detailed below:
1.- Behavior of the CFM Curve:
The CFM curve is a rectangular hyperbola that descends asymptotically to both axes (from Y to X); This is because the fixed cost is a constant value, and as the units produced increase, the ratio (CF / Q) decreases.
2.- Behavior of the CVM Curve:
The CVM curve descends, reaches its minimum point and then begins to rise, this is because as the Average Variable Cost is the result of the reciprocal of the Average Product times the price (CVM = P. (1 / PM)), as the behavior of the Average Product is that it normally increases, reaches its maximum level and then decreases; then, the Average Variable Cost, must descend, reach its minimum point and then rise.
3.- Behavior of the CTM Curve:
The CTM Curve, descends at the beginning, reaches its minimum level and then rises, this is due to the fact that as CTM = CFM + CVM, and since the CFM gradually decreases until it is asymptotic to the abscissa axis, and, the CVM at the end of their behavior rises to its highest level; then, initially, the marked decrease in CFM causes CTM to decrease, but when the increase in CVM exceeds the decrease in CFM, CTM reaches its lowest point and begins to rise.
4.- Behavior of the CMg Curve:
The CMg Curve, descends reaching its minimum level and then ascends; This is because since the Marginal Cost is the result of the reciprocal of the Marginal Product by the price (CMg = P. (1 / PMg)), as the behavior of the Marginal Product is that it normally increases, reaches its maximum level and then decreases; then, the Marginal Cost, must descend, reach its minimum point and then rise.
5.- Relationship between CVM and CMg Curves:
When CVM is at its minimum it equals (cuts) to CMg.
6.- Relationship between the CFM, CVM and CTM Curves:
As CFM asymptotically approaches the abscissa axis, CVM asymptotically approaches CMT.
7.- Relations between the CMg, CVM and CTM Curves:
- When CVM and CTM reach their minimum level they equal (cut) to CMg. CMg is below CVM and CTM, when these curves descend; and, above when these rise.
Below is the graph of the short-term curves, where the aforementioned properties of each of them and the relationships between them can be observed and analyzed.
RELATIONSHIP BETWEEN TOTAL AND AVERAGE CURVES IN THE SHORT-TERM
If two tangents are drawn in the total cost curves, one tangent to the TC and another tangent to the CFT, we find the following relationships:
- The tangent to the CT curve corresponds to the minimum level of the CTM curve The tangent to the CVT curve corresponds to the minimum level of the CMV curve The portion of the CMg curve that is above CVM and e found between the two tangents, it is the short-term “O” OFFER curve (in perfect competition); In this way, the producer cannot offer their products below CVM, because they would not even cover the CVM that they have incurred to produce; Consequently, it can offer its products above CVM because even if it operates at a loss, at least part of the CFM incurred is recovered, even if production is stopped .
BIBLIOGRAPHIC REFERENCES
- Fergunson, CE and Gould JP Economic Theory. 1.985, Editorial FCE España Monchón, Francisco. Economics Theory and Practice. 1994, Mc Graw Hill. SpainNeuner, John, Cost Accounting - Principle and Practice. 1,980. Editorial Hispanoamérica, Mexico. t1.
