Distinguish between accounting cost and economic cost. Draw cost curves and highlight the relationship between AC and MC.

Distinguish between accounting cost and economic cost. Draw cost curves and highlight the relationship between AC and MC.

Meaning-

Cost may be defined in simple terms as sacrifice or foregoing which has already occurred or has potential to occur in future with an objective to achieve a specific purpose measured in monetary terms.

Cost Function:C= f (Q,T,P_f) where C= cost, Q= Output, T technology, P_f = Price of  inputs.

Accounting cost is the cost that can be recorded in the books of accounts. Money cost or Nominal Cost. Also termed as explicit cost, these are costs for which explicit payment has been made in the past or will be made in future.

Economic Cost: These are the costs that does not involve actual Payment or cash outflow or reduction in assets or increase in liability. Self owned resources rent of own property, interest of own capital

Relationship between AC and MC:

There exists a close relationship between AC and MC.

i. Both AC and MC are derived from total cost (TC). AC refers to TC per unit of output and MC refers to addition to TC when one more unit of output is produced.

ii. Both AC and MC curves are U-shaped due to the Law of Variable Proportions. The relationship between the two can be better illustrated through following schedule and diagram.

 The main points of relationship between TC and MC are:

1. Marginal cost is the addition to total cost, when one more unit of output is produced. MC is calculated as: MC_n = TC_n – TC_n-1

2. When TC rises at a diminishing rate, MC declines.

3. When the rate of increase in TC stops diminishing, MC is at its minimum point, i.e. point E in Fig. 6.12.

4. When the rate of increase in total cost starts rising, the marginal cost is increasing.