Chapter 7 ( the theory and estimation of cost )
Q 1 : Define and compare the following type of cost:
a) Sunk cost versus incremental cost.
- sunk cost : is the cost that doesn't vary in accordance with
decision alternative.
- Incremental cost : is that varies with the range of option
available in a decision.
b) Fixed cost versus variable cost.
- Fixed cost : are associated with the existence of the manager,
the plant, and the equipment. Such as contractual salaries and
insurance premiums. They continue at the same levels or rates
irrespective of the rate of production, even if it is zero. Once
the plant has been put in place, these fixed or overhead costs
are, "sunk" costs, and sunk costs are not relevant to any
rate-of-production decisions
- Variable cost : are those which vary with the level of
productive output. Variable costs are always relevant to the
rate-of-production decision.
c) Incremental cost versus marginal cost.
- Incremental cost : is that varies with the range of option
available in a decision.
- Marginal cost : is the rate of change in total variable cost.
Also the change in total cost with respect to change in output.
When MC decrease MP increase.
d) Opportunity cost versus out of pocket cost.
- Opportunity cost : is the amount of subjective value that is
forgone in choosing one activity over the next best alternative.
So it is refer to indirect or implicit cost.
- Out of pocket cost : is refer to direct or explicit cost. is
pecuniary, accounting cost by virtue of the fact that such
money-denominated costs are visible, readily monitored, and
hence easily included by accountants.
e) Historical cost versus Replacement cost.
- Historical cost : is the amount paid in the past to obtain a
good.
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- Replacement cost : is the amount should pay now to get the
same good. So replacement is relevant because it has an
impact on the alternative being considered.
Q 8 : Define economics of scope. Is this concept related to economics of scale?
Explain.
- Economics of scope : is the reduction of a firm's unit cost by
producing two or more goods or services jointly rather than
separately.
- Economics of scale: It means that a company average cost
decreases at higher level of output so it's implies along run
time period.
Engaging in more than one line of business may require a firm to
have certain scale of production. Also if the company expansion
into different lines of business naturally increase it's scale of
production.
In sense the concept of Economics of scope is closely related to
Economics of scale.
P 11 : Discuss the following three cost function
- TC = 20 + 4Q
- TC = 20 + 2Q + 0.5Q²
- TC = 20 + 4Q - 0.1Q²
a) Calculate all cost curves:
 Total cost.
 Total fixed cost.
 Total variable cost.
 Average total cost.
 Average fixed cost.
 Average variable cost.
 Marginal cost.
b) Plot these curves on graphs.
c) Compare the shapes of these curves and discuss their characteristics.
2
TC = 20 + 4Q
Q
TFC
TVC
TC
AFC
AVC
ATC
MC
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
20.00
0.00
20.00
0.00
0.00
0.00
0.00
20.00
4.00
24.00
20.00
4.00
24.00
4.00
20.00
8.00
28.00
10.00
4.00
14.00
4.00
20.00
12.00
32.00
6.67
4.00
10.67
4.00
20.00
16.00
36.00
5.00
4.00
9.00
4.00
20.00
20.00
40.00
4.00
4.00
8.00
4.00
20.00
24.00
44.00
3.33
4.00
7.33
4.00
20.00
28.00
48.00
2.86
4.00
6.86
4.00
20.00
32.00
52.00
2.50
4.00
6.50
4.00
20.00
36.00
56.00
2.22
4.00
6.22
4.00
20.00
40.00
60.00
2.00
4.00
6.00
4.00
20.00
44.00
64.00
1.82
4.00
5.82
4.00
20.00
48.00
68.00
1.67
4.00
5.67
4.00
20.00
52.00
72.00
1.54
4.00
5.54
4.00
20.00
56.00
76.00
1.43
4.00
5.43
4.00
20.00
60.00
80.00
1.33
4.00
5.33
4.00
50.00
45.00
40.00
35.00
30.00
TFC
TVC
25.00
TC
20.00
15.00
10.00
5.00
0.00
16 15 14 13 12 11 10
9
3
8
7
6
5
4
3
2
1
0
25.00
22.00
19.00
16.00
AFC
13.00
AVC
ATC
10.00
MC
7.00
4.00
1.00
16 15 14 13 12 11 10
9
8
7
6
5
4
3
2
1
0 -2.00
TC = 20 + 2Q + 0.5Q²
Q
TFC
TVC
TC
AFC
AVC
ATC
MC
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
20.00
0.00
20.00
0.00
0.00
0.00
0.00
20.00
2.50
22.50
20.00
2.50
22.50
2.50
20.00
6.00
26.00
10.00
3.00
13.00
3.50
20.00
10.50
30.50
6.67
3.50
10.17
4.50
20.00
16.00
36.00
5.00
4.00
9.00
5.50
20.00
22.50
42.50
4.00
4.50
8.50
6.50
20.00
30.00
50.00
3.33
5.00
8.33
7.50
20.00
38.50
58.50
2.86
5.50
8.36
8.50
20.00
48.00
68.00
2.50
6.00
8.50
9.50
20.00
58.50
78.50
2.22
6.50
8.72
10.50
20.00
70.00
90.00
2.00
7.00
9.00
11.50
20.00
82.50
102.50
1.82
7.50
9.32
12.50
20.00
96.00
116.00
1.67
8.00
9.67
13.50
20.00
110.50
130.50
1.54
8.50
10.04
14.50
20.00
126.00
146.00
1.43
9.00
10.43
15.50
20.00
142.50
162.50
1.33
9.50
10.83
16.50
4
50.00
45.00
40.00
35.00
30.00
TFC
TVC
25.00
TC
20.00
15.00
10.00
5.00
0.00
16
15 14
13
12 11
10
9
8
7
6
5
4
3
2
1
0
25.00
22.00
19.00
16.00
AFC
13.00
AVC
ATC
10.00
MC
7.00
4.00
1.00
16
15 14
13
12 11
10
5
9
8
7
6
5
4
3
2
1
0 -2.00
TC = 20 + 4Q - 0.1Q²
Q
TFC
TVC
TC
AFC
AVC
ATC
MC
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
20.00
0.00
20.00
0.00
0.00
0.00
0.00
20.00
3.90
23.90
20.00
3.90
23.90
3.90
20.00
7.60
27.60
10.00
3.80
13.80
3.70
20.00
11.10
31.10
6.67
3.70
10.37
3.50
20.00
14.40
34.40
5.00
3.60
8.60
3.30
20.00
17.50
37.50
4.00
3.50
7.50
3.10
20.00
20.40
40.40
3.33
3.40
6.73
2.90
20.00
23.10
43.10
2.86
3.30
6.16
2.70
20.00
25.60
45.60
2.50
3.20
5.70
2.50
20.00
27.90
47.90
2.22
3.10
5.32
2.30
20.00
30.00
50.00
2.00
3.00
5.00
2.10
20.00
31.90
51.90
1.82
2.90
4.72
1.90
20.00
33.60
53.60
1.67
2.80
4.47
1.70
20.00
35.10
55.10
1.54
2.70
4.24
1.50
20.00
36.40
56.40
1.43
2.60
4.03
1.30
20.00
37.50
57.50
1.33
2.50
3.83
1.10
50.00
45.00
40.00
35.00
30.00
TFC
TVC
25.00
TC
20.00
15.00
10.00
5.00
0.00
16 15 14 13 12 11 10
9
6
8
7
6
5
4
3
2
1
0
25.00
22.00
19.00
16.00
AFC
AVC
13.00
ATC
10.00
MC
7.00
4.00
1.00
16 15 14 13 12 11 10 9
8
7
6
5
4
3
2
1
0 -2.00
From graphs we noticed :
- Total fixed cost : is the same in the three cost function and its
curve has stable level and doesn’t effected by increase or
decrease of quantity.
- Total variable cost :
 First function : TC = 20 + 4Q
Increase in cost is stable and by fixed rate of change
and that appear in the liner curve.
 Second function : TC = 20 + 2Q + 0.5Q²
Increase in cost is more than first function and by
incremental rate of change and that appear in the
crescent or quadratic curve.
 Third function : TC = 20 + 4Q - 0.1Q²
There in a decrease in cost compared with first and
second function and by decrement rate of change and
that appear in the concave or cubic curve.
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- Total cost :
 First function : TC = 20 + 4Q
Increase in cost is stable and by fixed rate of change
and that appear in the liner curve.
 Second function : TC = 20 + 2Q + 0.5Q²
Increase in cost is more than first function and by
incremental rate of change and that appear in the
crescent or quadratic curve.
 Third function : TC = 20 + 4Q - 0.1Q²
There in a decrease in cost compared with first and
second function and by decrement rate of change and
that appear in the concave or cubic curve.
- Average fixed cost : is the same comment as total fixed cost.
- Average variable cost : is the same comment as total variable
cost.
- Average total cost : is the same comment as total cost.
- Marginal cost :
 First function : TC = 20 + 4Q
cost is stable and that appear in the liner curve.
 Second function : TC = 20 + 2Q + 0.5Q²
Increase in cost is more than first function and by
incremental rate of change and that appear in the
upward curve.
 Third function : TC = 20 + 4Q - 0.1Q²
There in a decrease in cost compared with first and
second function which appear in the downward curve.
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