Cost Function (Types and Concepts)

1) What is “cost” in microeconomics?

In production theory, once we know the technology $Q=f(\cdot)$ , the firm’s cost depends on:

how much output it wants to produce ( $Q$ ),
prices of inputs (e.g., wage $w$ , rental rate of capital $r$ ),
and the firm’s choice of input combination (cost minimization).

So cost is not purely technological. It is technology + input prices + optimization.

A general cost function is:

C = C(Q; w, r, \text{technology})

Interpretation: Minimum cost needed to produce output $Q$ given input prices and technology.

2) Explicit vs implicit costs; economic vs accounting cost

2.1 Explicit costs

Direct monetary payments:

wages, rent, raw materials, electricity, transport, etc.

2.2 Implicit costs (opportunity costs)

Value of resources owned by the firm/entrepreneur:

owner’s time (foregone salary),
own building (foregone rent),
own capital (foregone interest).

2.3 Accounting cost vs economic cost

Accounting cost: typically counts explicit costs only.
Economic cost: counts explicit + implicit (opportunity cost).
Economic cost is the relevant concept for profit maximization in microeconomics.

CUET PG trap: Questions may ask “What cost concept is used in economic profit?” → economic cost (includes opportunity costs).

3) Short-run cost concepts (at least one input fixed)

In the short run, some inputs are fixed (e.g., plant size). Thus costs split into:

3.1 Total Fixed Cost (TFC)

Costs that do not change with output in the short run:

rent of factory building,
fixed salaried staff,
machinery depreciation (in some treatments),
license fees.

TFC is constant with respect to Q.

3.2 Total Variable Cost (TVC)

Costs that vary with output:

raw materials,
wages of casual labour,
fuel, packaging.

Typically increases as output increases.

3.3 Total Cost (TC)

TC(Q) = TFC + TVC(Q)

Graph shape:

TFC: horizontal line.
TVC: starts near zero and rises (often S-shaped).
TC: starts at TFC and rises like TVC shifted upward.

4) Average and marginal cost (short run)

4.1 Average Fixed Cost (AFC)

AFC = \frac{TFC}{Q}

AFC declines as output increases (spreading fixed cost).

4.2 Average Variable Cost (AVC)

AVC = \frac{TVC}{Q}

4.3 Average Total Cost (ATC) or AC

AC = \frac{TC}{Q} = AFC + AVC

4.4 Marginal Cost (MC)

MC = \frac{\Delta TC}{\Delta Q} = \frac{\Delta TVC}{\Delta Q}

Because fixed cost doesn’t change with output, MC depends only on variable cost changes.