Theory on Costs

The concept of determining the price for a particular product is not an easy thing to do. The cost theory implies that supply and expenditure can determine the cost of business. The function may vary depending upon the factors like operations of scale, size of output, price of production, etc. The theory of cost production is crucial for the company to increase its profits. 

The Types of Production Function

There are three main types of a production function that are here:

• Cobb-Douglas production function
• Leontief production function
• CES production function

Cobb-Douglas Production Function

The production function of Cobb-Douglas is based upon the study of the American manufacturing industry. Production function is considered the linear homogeneous production function that considers only two inputs: labour and capital, to calculate the entire output of the manufacturing industry.

The production function of Cobb- Douglas involves: 

Q = for output

K = for capital

L = for labour

Where A is a positive constant

Properties of Cobb- Douglas Production Function

The properties of the production function involve the mathematical properties that make the Cobb-Douglas production function helpful for managerial decision making.

It states that the marginal product of labour and capital depends on the quantities of labour and capital used in the production process.

Types of Production Cost 

There are two main types of production costs: 

1. Long term cost
2. Short term cost

Long-run cost

Long term Cost is a complex concept. It includes the cost, which cannot be changed in the short run. Long-term cost generally includes fixed costs. 

Short-run cost

Short-term cost includes the cost that can be changed in the short run to increase production. There are two types of short-run costs: short term and long term. 

• These costs have short term influences on the manufacturing procedures. 
• These are the types of costs that, if sustained, cannot be used again, such as the cost price of raw materials, etc. 
• When we talk about the short-run, one aspect of reduction needs to remain constant while the other is variable. 
• Therefore, in the short run, the degree of and result of output can only be increased by increasing the value of aspects like raw materials, labour, etc. 
• At the same time, the factors like capital and plant size remain constant. 

Short-run Average Costs

1. AFC

Average fixed cost can be defined as the total fixed cost divided by the number of units produced as TFC is a complete fixed cost and Q number of units produced. Then, AFC can be defined as the fixed cost according to the output unit.

2. AVC

Average variable cost can be defined as a total variable cost divided by the number of units produced. TVC is the total fixed cost and q is the number of units produced. Therefore, AVC is a variable cost per unit of output.

3. Average total cost

The total cost can be defined as the submission of average variable and average costs. 

Marginal Cost

One of the essential concepts in the short-run average cost is marginal cost. Marginal cost can be defined as the addition made in the cost of production by producing an additional unit of output. In the short-run marginal cost depends only on variable cost as total cost remains constant.

Comparison of Short-run and Long-run Costs

• According to the cost analysis theory, the company may try to increase its output during the short-run period by changing factors like raw material and labour. At the same time, the fixed variables remain untouched. 
• Whereas in the long run, the company can change any factor to obtain the desired result.

Conclusion

Short-term, the average variable cost curve of the contracting firm will be U-shaped, since at very low outputs there are some difficulties in the effective use of resources, and at very high outputs in the short-term, in which head office and some site management are fixed, managerial inefficacy and organisational problems are likely to lead to increased costs of the other inputs, with manpower being particularly dependent on efficient management. Fixed costs are relatively small in traditional construction. Still, they suffice to make very small outputs expensive. Hence, the total average cost curves rise more steeply to the left of their lowest point and slightly less steeply to its right than was the case when only variable costs were considered. There was some discussion of the postponable costs, namely part of the normal return on the entrepreneur’s labours, and some of the return on capital invested, depending on whether interest must be paid regularly, whether capital can be withdrawn from the business and whether the firm wishes to expand.