DEFINITION OF COST OF PRODUCTION

            DEFINITION OF COST OF PRODUCTION

Cost production may be defined as the sum total of all the payments to the factors of production is used in the production of goods and services.

For goods and services to be produced, all the four factors of production are land, capital, labour and entrepreneur, work together.

The various costs incurred in use of these factors of production in order produce goods and services are referred to cost of production.

Cost of production can re related to all the rewards due to factors of production, which include rent for land, wages salaries for labours, interest for capital and i for entrepreneur.

            BASIC COST CONCEPTS

(1)       Fixed cost (FC): Fixed cost also called d cost or unavoidable cost is defined as the cost or expenses that remain unchanged whatever the level of output. It simply means the cost of an enterprise which does not change with change of output. In other words, fixed cost does not change with the changing output.

Thus, no matter the quantity of commodity produced, fixed cost remains the same. Fixed cost can be represented by a graph as shown in

examples of fixed cost

Examples of fixed cost are the cost of buildings, land, motor vehicles and plant and machinery. Fixed cost is calculated by this formula:

FC – TC-VC OR

TFC = AFC x Quantity produced.

(2)       Variable Cost (VC): Variable Cost, also called direct cost, is defined as the cost of production which varies or changes directly with the level of output.

Variable cost has the tendency to rise as more of a commodity is produced and reduce as less of the commodity is produce.

 Variable cost can be represented by a graph as shown in Fig. 23.2. Examples of variable cost includes cost of fuel, raw materials, labour etc. Variable cost is calculated by this formula: VC= TC – FC

(3)        Total cost (TC): Total cost may be defined as the total sum of fixed and variable costs incurred by an enterprise in the production of a particular commodity.

Total cost, represented in Fig.23.3, is made up of two parts: total fixed cost (TFC) and total variable cost (TVC). Total cost can be calculated with this formula: TC = FC+VC or TC = ATC x Q.

(4)      Average cost (AC) or Average Total Cost (ATC): Average cost is defined as a cost per unit of output or the total cost of production of a commodity incurred by an enterprise divided by the number of units of output.

Average total cost (ATC) is divided into average fixed costs (AFC) and average variable costs (AVC).

(5)      Average variable costs (AVC): The average variable cost may be defined as the cost per unit of variable cost of output. As production  increases, average variable cost may rise or fall.

The average variable cost, which can be represented graphically in Fig. 23.5, is obtained by dividing the total variable costs by the total number of output. It is calculated by this formula.

                      AVC

AVC =          TQ       =          ATC – AFC

(6)      Average fixed cost (AFC): Average fixed cost may be defined as the fixed cost of producing a unit of output. It is represented graphically in Fig. 23.6. Average fixed cost is obtained by dividing fixed cost (FC) by the number of units of output as reflected in this formula.

(7)     Marginal Cost (MC): Marginal cost also called incremental cost, may be defined as the extra cost of increasing output by one more unit. In other words, marginal cost is the cost difference in producing an additional unit of an enterprise’s output.

For example, if the cost of producing 20 tubers of yam is N50.00 and it cost N60.00 to produce 21 tubers of the same yam, the N10.00 difference in cost is known as marginal cost.

Marginal cost is represented graphically in Fig. 23.7 and is calculated using this formula:

=Changes in TC                             =     DPC

Changes in output                       DQ

            RELATIONSHIP BETWEEN TOTAL AVERAGE AND MARGINAL COSTS

The different types of costs are interrelated in a number of ways.

  • The average cost is obtained when the total cost is divided by the total output.
  •  The average fixed cost when added to the average variable cost gives the total cost.
  •  The marginal cost is derived from the difference between two consecutive total costs.
  •  Marginal cost is equal to average cost when the average cost is at its lowest point.
  • As the total cost increases, marginal cost falls up to a point at which average cost is lowest.

      RELATIONSHIP BETWEEN VC, MC, AVC, ATC AND AFC

(1)        The marginal cost curve cuts the average cost curve from below at its lowest point.

(2)      The nature of the marginal and average cost curves shows that as the level of output increases, both costs decreases up to a point.

(3)        When the average cost is falling, the marginal cost is below it while the average  cost starts rising.

(4)        The marginal cost will cross the minimum point of average total cost before rising.
(5)        The average fixed cost curve falls as output increases because the fixed cost is spread over a larger

output level. The relationship among these costs.

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