Basic Cost Concepts: Total, Average, Marginal, Fixed And Variable Cost - SS2 Economics Lesson Note

The cost of production is the money value of the resources utilised in the production process. The profit is the attained sales revenue (that is, the market value of the products or services sold) minus the costs of production (the money value of resources, factors of production). 

Costs and economic activities are closely related, and affect one another in every aspect of the economy. An analysis of costs plays a very important role in helping us understand economic situations. An accurate costs analysis requires a careful consideration of all relevant decision alternatives.  Costs are an essential part of business, and understanding the different cost concepts is crucial for making informed decisions. The basic cost concepts include total cost, average cost, marginal cost, fixed cost, and variable cost.

• Total cost (TC) is the sum of all the costs incurred in the production process, including both fixed and variable costs. Mathematically, 

TC = FC + VC

Where FC = fixed cost,  VC = variable cost

 

• Average cost (AC) is the total cost divided by the quantity of output produced. Mathematically, 

AC = TC/Q

Where TC = total cost,  Q = quantity of output produced

 

• Marginal cost (MC) is the additional cost incurred by producing one more unit of output. Mathematically,

MC = ΔTC/ΔQ =  TC¹ - TC°/Q¹ - Q°

Where TC¹ - TC° = change in total cost,  Q¹ - Q° = change in quantity of output produced

 

• Fixed cost (FC) is a cost that does not change with the level of production, such as rent or salaries. 

FC = TC - VC

Where TC = Total cost,  VC = variable cost

 

• Variable cost (VC) is a cost that varies with the level of production, such as raw materials or labor.

VC = TC -  FC

Where FC = fixed cost,  TC = total cost