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Current Category » Economics of Natural Resources & Farm Management

Cost-type and Concepts

The term ‘cost’ generally refers to the outlay of funds & or productive purposes. In other words, cost refers to the expenses incurred on productive services and physical input factors.

Cost analysis is an important tool to describe the relationship of costs to income. Commonly, there are two types of costs used in farming viz fixed costs and variable costs. However, marginal or added cost is also en important tool to guide the farmer to decide, how far he can push the production and how much of various resources he can USC.

The total sums of fixed and variable costs in the production of a particular commodity are called as total cost. There are other costs which have boon derived from those main groups.

1) Fixed Costs:
These costs are related to fixed resources and are overhead costs. They remain constant irrespective of the yields obtained.
These are the same at all levels of production. Rent, interest on fixed capital, depreciation of building, taxes and wages of the permanent labourers constitute fixed costs Fixed costs have little relation to making decision on the level of production of farming practices.

2) Variable Costs:
These costs are related to the variable resources and change with the output. The variable costs are nil, if there is no production on the farm. They change with the quantity of production. In the beginning, as the production creases variable costs rise quite rapidly, but with further rise in production variable costs do not increase proportionately with the production due to economics brought about by mass production later on as diminishing returns set in, variable costs start rising more rapidly than the production.
If farming is to be carried, the variable cost must be less than selling price, e.g. current supplies such as seeds, fertilizers, irrigation, insecticides, hired labour charges, interest on working capital.

3) Total Costs:
The fixed and variable costs make total cost of production of each unit of crop or livestock product. The total cost stands even when production is zero. The increase in variable costs determines whether farming would be profitable, but once the total costs are covered, the farmer remains indifferent to the average cost of per unit cost of production.
Profit = Gross income - Total Cost (Fixed Variable)

4) Average total Cost:
It refers to the average of all costs (fixed + Variable) per Unit of output. It is the resultant of total cost divided by the output. In the beginning the average costs are very high because the high fixed costs are distributed on a few units of production. But as more units are produced the fixed cots are spread over on more and more units. When the fixed costs have spread over on many units, there is not much effect of the fixed costs on the average costs. Variable costs assume importance s average cost begin to rise,
                                 Fixed Cost + Variable cost         Total Cost
Average total cost =------------------------------------ = ---------------------- 
                                  Total output. Total output         Total output

5) Average Fixed Cost:
Average fixed cost is a fixed cost per unit of output. The total fixed cost is the same at all the levels of production. The average fixed cost falls continuously at a decreasing rate as more output is produced. It is because the fixed cost is divided by increasingly large number as output increases. It can be expressed as
             TFC
AFC= ----------
             Y
Where, AFC = Average Fixed Cost
             TFC = Total Fixed Cost
               Y   = Output.

6) Average Variable Cost:
The average variable cost (AVC) refers to total variable cost per unit of output. The AVC has an inverse relationship with average product (AP). When AP increases AVC decreases, when AP decreases AVC increases, further more, when AP is at maximum the AVC must be at its minimum. The AVC is expressed as

AVC= VC/Y
Where, VC= Variable cost
             Y= Output

7) Marginal Cost:
Marginal cost MC is the change in cost associated with an increase of one unit of output. The marginal cost has also certain relationship with Marginal Product (MP) just as the average variable cost has with average product.

There is an inverse relationship between Marginal Product (MP) and Marginal Cost (MC) that is when MP is increasing, MC is decreasing, when MP is decreasing MC is increasing and when MP is at maximum MC is at lowest point.
As marginal costs are related to the cost of producing additional units of output, they are affected only by the variable costs Fixed cost, as a rule, do not influence the marginal cost, because they neither increase nor decrease with the additional production. Marginal costs arc very important in determining as to how far production should be pushed and how much of the various resources should be used. A farmer should acid to the production as long as added return is greater or at least equal to the added cost.

Current Category » Economics of Natural Resources & Farm Management