Economics: Cost and Revenue: Types of Cost, Total and Average Cost

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Cost

Cost is defined as the money expenditure incurred by the producer to purchase (or hire) factors of production and raw materials to produce goods and services. In a way, cost is a kind of sacrifice made by the producer. Example, a farmer producing rice. The production of rice involves the following:

  • getting the land for cultivation

  • using labour to prepare the land and make it suitable for growing the crop. This includes tilling the soil, sowing seed, fertilizing and irrigating the land and finally harvesting.

  • Transporting rice to godown/mandi.

  • All the expenses incurred by the farmer in the whole process is called cost.

Types of Cost

There are various types of cost which are as follows:

Types of Cost

Types of Cost

Fixed Cost

Fixed cost is defined as the expenditure, on hiring or purchasing of fixed factors/ inputs, which are compulsory and has nothing to do with the amount of production of the good or service. Ex. rent paid for the use of tractor is also a fixed cost.

Variable Cost

We can define variable cost as the expenditure on variable factors/inputs, such as labour, which can be changed.

Explicit Cost

Explicit cost is defined as the money expenditure incurred by the producer on both fixed and variable factors of production and raw materials etc.

Implicit Cost

Implicit cost is the cost of self-supplied factors. The value of such cost has to be calculated on the basis of market value.

Total and Average Cost

Total Cost

  • Total cost is the sum of total fixed cost and total variable cost which are given explicitly.

  • We can also write, Total Cost (TC) = Total Fixed Cost + Total Variable Cost

Average Cost

  • Average total cost or simply the average cost is the ratio of total cost to the total output.

  • Average Cost is the cost per unit of output.

  • We can also write, Average Cost (AC) = Total Cost/Total Output

Marginal Cost

  • Marginal cost is defined as increase in the total cost due to increase in one extra unit of output. Increase in total output will lead to increase in total cost of production.

  • We can also write, Marginal Cost (MC) = Change in Total Cost/Change in Quantity

Revenue

  • Revenue is defined as the amount a person receives by selling a certain quantity of the commodity. Revenue can be calculated by multiplying price and quantity of the commodity. Hence, we can write,

  • Revenue = Price of the Commodity × Quantity of the Commodity

  • The total amount of money received by the seller during that time period is called total revenue. Another term used for “total revenue” is total sales proceeds. Because revenue is received by selling a commodity. It is also called total sales proceeds from that Commodity.

  • Total Revenue = Price × Quantity or TR = P × Q

Average and Marginal Revenue

Average Revenue (AR)

  • Average revenue is simply the revenue earned per unit of the output. In short, it is the price of one unit of the output. Average revenue is expressed as follows:

  • Average Revenue = Total Revenue/Quantity sold

  • Symbolically, AR = TR/Q

  • Take the case of a single commodity, we know that

  • TR = P × Q So AR = P × Q/Q = P

  • Average Revenue and Price of the commodity are one and the same.

Marginal Revenue (MR)

Marginal Revenue (MR) is defined as increase in total revenue due to one unit increase in the sale of the quantity of output. Marginal revenue is expressed as follows:

Marginal Revenue (MR) = Rate of change in Total Revenue/ Rate of change in Quantity of the commodity sold.

Use of Revenue and Cost

Cost is the expenditure incurred to produce a good or service during the production process, revenue is the money received by the producer by selling that good or service. So, cost symbolizes sacrifice made by the producer and revenue symbolizes gains for the producer. By getting the required revenue from sale of the commodity the producer is able to recover the cost he has incurred earlier. In that case we say that the producer earned his due share which is called profit. We can define that profit is the surplus of revenue over the total cost of production.

Profit = Total Revenue – Total Cost.

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