Definition
Cost is the total expenditure incurred in producing a commodity. In Economics: Cost = Explicit Cost + Implicit Cost.
In everyday language, cost means "lागत" — the expense of producing or acquiring something. A producer who manufactures any good or service must deploy factors of production (land, labour, capital, enterprise), and each factor commands a payment. The sum total of all such payments — whether actually paid out or merely foregone — constitutes the economic cost of production.
Section 02
Explicit Cost vs. Implicit Cost Exam Favourite
Explicit Cost
Definition — Explicit Cost
Payments actually made in money to outsiders (factors of production not owned by the producer) for their services. Also called Accounting Cost or Out-of-pocket Cost.
Wages paid to hired workers
Rent paid on leased premises
Interest paid on borrowed capital
Payment for raw materials, electricity, internet
Money actually leaves the producer's pocket
Implicit Cost
Definition — Implicit Cost
The estimated value of inputs supplied by the owner himself for which no actual money payment is made. Also called Imputed Cost or Cost of Self-supplied Factors.
Estimated rent of own land used in production (instead of leasing it out)
Interest on own capital invested (instead of depositing in a bank)
Imputed salary of the entrepreneur's own services
No money leaves the pocket — it is a cost of not using the factor in its next best use
Basis
Explicit Cost
Implicit Cost
Nature
Actual money payment
Estimated / imputed cost
To whom paid
Outsiders / hired factors
Owner-supplied factors
Cash flow
Cash leaves the firm
No cash outflow
Included in accounting?
Yes
No
Included in economics?
Yes
Yes
Example
Rent paid, wages paid
Own building used, own capital invested
Core Formula
Economic Cost = Explicit Cost + Implicit Cost
Exam Key Point
In Accounting, only Explicit Costs are recognised. In Economics, BOTH Explicit + Implicit are included. This is why Economic Profit ≠ Accounting Profit.
Section 03
Opportunity Cost Important
Definition
Opportunity Cost is the cost of the next best alternative foregone when a particular choice is made. It is the value of what you give up in order to get something else.
Example 1: Three job offers: ₹25,000, ₹35,000, ₹45,000. If you accept ₹45,000, the opportunity cost is ₹35,000 (the next best foregone option).
Example 2: A producer uses his own building instead of renting it out at ₹20,000/month. The opportunity cost = ₹20,000/month (rent foregone).
Key Principle
Opportunity Cost = Cost of the Next Best Alternative Foregone (not the worst, not all alternatives — only the immediate next best).
Section 04
Cost Function
Definition
The Cost Function expresses the functional relationship between cost of production and the level of output. It shows how cost varies as output changes.
Just as we have Demand Function, Supply Function, and Production Function, we have a Cost Function which maps output (Q) to the cost (C) of producing that output.
General Form
C = f(Q) → Cost is a function of Output
Section 05
Short-Run Cost Framework Core Chapter
In the Short Run, some factors of production are fixed and others are variable. Consequently, costs are also classified into fixed and variable.
The complete short-run cost framework has three cost categories:
Category
Sub-components
Formula
Total Costs
TFC, TVC → TC
TC = TFC + TVC
Average Costs
AFC, AVC → ATC
ATC = AFC + AVC = TC/Q
Marginal Cost
MC
MC = ΔTC/ΔQ = TCₙ − TCₙ₋₁
Section 06
Total Fixed Cost (TFC)
Definition
Total Fixed Cost (TFC) refers to those costs which do not vary with the level of output. They remain constant regardless of how much or how little is produced — even if output is zero.
Also called Overhead Costs, Unavoidable Costs, or Supplementary Costs
Examples: Rent of factory, insurance premium, interest on fixed capital, depreciation on machinery, salary of permanent staff
Must be paid even when the firm produces zero output
TFC is a sunk cost in the short run — cannot be recovered by stopping production
Numerical Illustration
Output (Q)
TFC (₹)
0
12
1
12
2
12
3
12
4
12
TFC Curve
Figure 1 — Total Fixed Cost (TFC) Curve
Shape of TFC CurveHorizontal straight line parallel to the X-axis. The curve begins at a positive value on the Y-axis (not at the origin) and never slopes — it is perfectly flat throughout.
Exam Point
"Which cost is incurred even at zero level of output?" → Fixed Cost (TFC).
Section 07
Total Variable Cost (TVC)
Definition
Total Variable Cost (TVC) refers to those costs which vary directly with the level of output. They increase as output increases and decrease as output decreases. At zero output, TVC = 0.
Also called Prime Costs or Direct Costs
Examples: Cost of raw materials, wages of casual labour, fuel and power charges, packaging costs
TVC = 0 when Q = 0 (no production → no variable inputs needed)
TVC initially increases at a decreasing rate, then at an increasing rate
Numerical Illustration
Output (Q)
TVC (₹)
Change in TVC
0
0
—
1
6
+6
2
10
+4 (decreasing rate)
3
15
+5
4
24
+9 (increasing rate)
TVC Curve — Inverse S-Shape
Figure 2 — Total Variable Cost (TVC) Curve
Shape of TVC CurveInverse S-shaped (∫ shape).
Phase 1: TVC rises at a decreasing rate (best input combination — Law of Variable Proportions, Stage I).
Phase 2: TVC rises at an increasing rate (diminishing returns — Stage III of LVP).
Why Inverse S? — Law of Variable Proportions
In Stage I of production, the variable factor is being used efficiently → each additional unit produces more → cost per additional unit falls → TVC grows slowly (decreasing rate). In Stage III, the variable factor is overused relative to the fixed factor → output falls → cost rises sharply → TVC grows steeply (increasing rate). The shape of TVC is the mirror image of the TP (Total Product) curve.
Section 08
Total Cost (TC)
Definition
Total Cost is the sum of Total Fixed Cost and Total Variable Cost. It represents the total expenditure incurred by a firm in producing a given level of output.
Formula
TC = TFC + TVC
Numerical Illustration
Output (Q)
TFC (₹)
TVC (₹)
TC = TFC + TVC (₹)
0
12
0
12
1
12
6
18
2
12
10
22
3
12
15
27
4
12
24
36
TC, TVC, TFC — All Three Curves Together
Figure 3 — TC, TVC, TFC Curves (Relationship)
Vertical distance between TC and TVC = TFC (always constant) | TC and TVC are parallel curves
Critical Relationship
The vertical distance between TC and TVC is always equal to TFC (which is constant). Therefore TC and TVC are parallel curves. TC curve starts at the TFC level (not at origin).
Exam Key Point
At zero output: TC = TFC (because TVC = 0 at Q=0). The gap between TC and TFC curves widens as output increases because TVC keeps growing.
Section 09
Average Fixed Cost (AFC) Exam Favourite
Definition
Average Fixed Cost is the fixed cost per unit of output. It is obtained by dividing Total Fixed Cost by the quantity of output produced.
Shape — Rectangular Hyperbola
AFC curve is a Rectangular Hyperbola. Key properties:
(1) AFC continuously falls as output increases — but never becomes zero.
(2) It never touches the X-axis (because TFC is never zero → AFC can never be zero).
(3) It never touches the Y-axis (because at Q=0, AFC = ∞).
(4) Area under the AFC curve at every point is equal (= TFC = constant).
Common Exam Question (May 2025 & June 2024)
"Can AFC be zero?" → Answer: NO. AFC = TFC/Q. Since TFC is always positive (never zero), dividing it by any finite Q will always give a positive (non-zero) value. AFC can approach zero but never reach it.
Section 10
Average Variable Cost (AVC)
Definition
Average Variable Cost is the variable cost per unit of output. It equals Total Variable Cost divided by quantity produced.
Formula
AVC = TVC / Q
Numerical Illustration
Q
TVC (₹)
AVC = TVC/Q (₹)
0
0
—
1
6
6.0
2
10
5.0 ↓
3
15
5.0 (minimum)
4
24
6.0 ↑
AVC first falls (6 → 5), reaches a minimum (5), then rises again (6). This gives it a U-shape.
Shape — U-Shaped Curve
AVC is U-shaped because of the Law of Variable Proportions. In the early stages, additional variable inputs are used efficiently (rising MP → falling AVC). Later, with too many variable inputs relative to fixed inputs, efficiency falls (falling MP → rising AVC).
Section 11
Average Total Cost (ATC / AC)
Definition
Average Total Cost (also called Average Cost or AC) is the total cost per unit of output. It is the sum of AFC and AVC.
Key Observation — Minimum Points
The minimum point of AVC always occurs to the LEFT of (before) the minimum point of ATC. This is because when AVC is at its minimum, AFC is still falling, pulling ATC further down. ATC reaches its minimum only when the upward pull of rising AVC exactly offsets the downward pull of still-falling AFC.
Key Observation — Vertical Distance
The vertical distance between ATC and AVC equals AFC. Since AFC continuously falls, the vertical gap between ATC and AVC keeps narrowing as output increases. However, ATC and AVC never intersect because AFC can never become zero.
Section 12
Marginal Cost (MC) Most Important
Definition
Marginal Cost is the additional (extra) cost incurred in producing one more unit of output. It is the change in Total Cost when output is increased by one unit.
(Since TFC is constant, change in TC = change in TVC only)
Numerical Illustration
Q
TVC (₹)
TC (₹)
MC = ΔTC (₹)
0
0
12
—
1
6
18
6
2
10
22
4 ↓ (falling)
3
15
27
5 ↑
4
24
36
9 ↑↑ (rising fast)
Important Property
MC is independent of Fixed Cost. Since MC = ΔTC/ΔQ and TFC does not change, only TVC changes. Therefore MC can be calculated from TVC alone: MC = ΔTV C/ΔQ.
Shape of MC Curve
MC curve is U-shaped (often described as "Nike tick" / "checkmark" shaped). It initially falls steeply, reaches a minimum, then rises steeply. The reason: Law of Variable Proportions — MP of variable input first rises (MC falls) then falls (MC rises).
Section 13
Relationships: TC, TFC, TVC 5/8 Mark Q
Axes: Output (Q) on X-axis; Cost (₹) on Y-axis.
Shape of TFC: Horizontal straight line parallel to X-axis (constant at all output levels).
Shape of TVC and TC: Both are Inverse S-shaped curves. Reason: Law of Variable Proportions.
At Q = 0: TVC = 0 (starts at origin); TC = TFC (TC does not start at origin).
TC and TVC are parallel: Vertical distance between TC and TVC = TFC (which is constant). Hence they are always equidistant.
TC and TFC diverge: Vertical distance between TC and TFC = TVC (which keeps increasing). Hence these two curves diverge.
Section 14
Relationships: AFC, AVC, ATC 5/8 Mark Q
Axes: Output (Q) on X-axis; Cost per unit (₹) on Y-axis.
Shape of AFC: Rectangular Hyperbola — continuously falls, never touches either axis.
Shape of AVC and ATC: Both are U-shaped curves. Reason: Law of Variable Proportions.
Minimum of AVC comes before minimum of ATC. When AVC is at minimum, AFC is still falling, pulling ATC down further.
Vertical distance ATC − AVC = AFC (continuously falling). The gap keeps narrowing.
ATC and AVC never intersect because AFC can never become zero.
Section 15
Relationship: MC with AVC & ATC Most Tested
Figure 7 — MC, AVC, ATC Together (The Classic Diagram)
MC cuts both AVC and ATC at their respective minimum points | Min AVC (Q₁) always comes before Min ATC (Q₂)
MC and AVC
MC < AVC → AVC is falling
MC = AVC → AVC is at minimum
MC > AVC → AVC is rising
MC cuts AVC at its minimum point
MC and ATC (AC)
MC < ATC → ATC is falling
MC = ATC → ATC is at minimum
MC > ATC → ATC is rising
MC cuts ATC at its minimum point
Special Case
After MC's minimum (MC rising) but before ATC's minimum → ATC still falls!
This happens because AFC still falling → drags ATC down
So: AC can fall even when MC is rising (for a while)
Minimum Points Order
MC minimum → first (earliest)
AVC minimum → second
ATC minimum → last (rightmost)
MC passes through both minimums
Section 16
Relationship: MC & TC / TVC
MC and TC
When MC is falling → TC increases at a decreasing rate (the slope of TC is getting flatter)
When MC is at its minimum → TC is at its point of inflection (changes its curvature from concave to convex)
When MC is rising → TC increases at an increasing rate (the slope of TC is getting steeper)
MC and TVC
Since TFC is constant, ΔTC = ΔTVC for any given change in output
Therefore: MC = ΔTVC / ΔQ as well → MC can be derived from TVC alone
Sum of MC values = TVC at that output level (area under MC curve = TVC)
MC is independent of TFC — changing fixed costs does NOT affect MC
Key Equivalence
MC = ΔTC/ΔQ = ΔTVC/ΔQ (because ΔTFC = 0)
Sum of MC values from Q=1 to Q=n = TVC at Q=n
Examination Ready
Most Important Exam Points
All items below are directly relevant to June 2024 and May 2025 question papers.
Shapes of Cost Curves
TFC → Horizontal straight line ∥ X-axis
TVC → Inverse S-shaped curve
TC → Inverse S-shaped curve
AFC → Rectangular Hyperbola
AVC → U-shaped curve
ATC / AC → U-shaped curve
MC → U-shaped curve (steep)
Core Formulae
TC = TFC + TVC
ATC = TC/Q = AFC + AVC
AFC = TFC/Q
AVC = TVC/Q
MC = ΔTC/ΔQ = TCₙ − TCₙ₋₁
MC = TVCₙ − TVCₙ₋₁ (also valid)
Econ Cost = Explicit + Implicit
Critical Relationships
TC − TVC = TFC (always constant)
ATC − AVC = AFC (always falling)
MC cuts AVC & ATC at their minimums
Min AVC < Min ATC (by position)
ATC & AVC never intersect (AFC ≠ 0)
Σ MC = TVC at any output level
Standard Theory Statements
U-shape of AVC, ATC, MC ← Law of Variable Proportions
Inverse S-shape of TVC, TC ← LVP
MC is independent of Fixed Cost
AFC can never be zero (TFC ≠ 0)
At Q=0: TVC=0; TC=TFC
AC can fall even when MC is rising
Past-Paper & Likely Questions
Very Important Exam Questions
MCQ — June 2024
The shape of short-run Average Fixed Cost (AFC) is: (a) U shaped (b) Rectangular Hyperbola (c) reverse U shaped (d) downward sloping straight line
✓ Answer: (b) Rectangular Hyperbola
MCQ — May 2025
As output level increases, Short-run Average Fixed Cost (AFC): (a) falls (b) remains constant (c) rises (d) becomes negative.
✓ Answer: (a) falls
MCQ — May 2025
All the following curves are U-shaped EXCEPT: (a) the MC curve (b) the AVC curve (c) the AC curve (d) the AFC curve.
✓ Answer: (d) the AFC curve (it is Rectangular Hyperbola)
5-Mark — May 2025
Can Average Fixed Cost (AFC) be zero? Explain with a diagram.
→ No. AFC = TFC/Q. TFC is always positive. Draw Rectangular Hyperbola. State it never touches X-axis.
5-Mark — May 2025
Explain the relationship between Marginal Cost (MC) and Average Cost (AC).
→ Draw MC and ATC together. MC < AC → AC falls. MC = AC → AC at minimum. MC > AC → AC rises. MC cuts AC at minimum. Also: AC can fall while MC rises.
Theory — Important
Distinguish between Explicit Cost and Implicit Cost with examples.
→ Define both. State Econ Cost = Explicit + Implicit. Give 2 examples each. Give tabular comparison.
5-Mark — Important
What is the relationship between Total Fixed Cost, Total Variable Cost, and Total Cost? Draw the diagram.
→ TC = TFC + TVC. TFC horizontal. TVC & TC = inverse S. TC starts at TFC level. Vertical gap TC−TVC = TFC (constant). Vertical gap TC−TFC = TVC (grows).
Numerical
From a table of TFC and TVC values for Q = 0 to 4, calculate: TC, AFC, AVC, ATC, and MC at each level.
→ Apply all formulae. Present as complete table with all 7 columns.
Additional Direct MCQs from Past Papers (Cost Chapter)
Q: When AP is maximum and constant: (a) MP=AP (b) MR=MC (c) MR=AR (d) all → Ans: (a) MP=AP
Q: Law of Variable Proportion explains ______ run production → Ans: Short run
Q: In short run, when only one factor is variable → Ans: Short-run production / Law of Variable Proportion
Q: Working capital refers to funds not invested in: (a) raw materials (b) finished goods receivables (c) cash (d) land → Ans: (d) land
Last-Minute Revision
Quick Revision Sheet
Cost Types
Econ Cost = Explicit + Implicit
Explicit = Actual cash payments
Implicit = Owner's own inputs
Opp. Cost = Next best foregone
Total Costs
TC = TFC + TVC
TFC: constant, ≥0 always
TVC: 0 at Q=0, grows after
TC = TFC when Q=0
Average Costs
AFC = TFC/Q → rect. hyperbola
AVC = TVC/Q → U-shaped
ATC = AFC + AVC → U-shaped
ATC−AVC = AFC (shrinks)
Marginal Cost
MC = ΔTC/ΔQ = ΔTVC/ΔQ
Independent of TFC
U-shaped curve
ΣMC = TVC
Curve Shapes
TFC → Horizontal line
TVC, TC → Inverse-S
AFC → Rect. Hyperbola
AVC, ATC, MC → U-shaped
MC Relationships
MC < AVC/ATC → they fall
MC = AVC/ATC → at minimum
MC > AVC/ATC → they rise
Min order: MC → AVC → ATC
Never / Always
AFC ≠ 0 (never)
ATC & AVC don't intersect
TVC = 0 at Q = 0
TFC exists even at Q = 0
LVP Link
U-shapes ← LVP
Inv-S ← LVP
LVP = Short-run production law
Stage I → MC/TVC grow slowly
Notes compiled from lecture transcript · Aligned with June 2024 & May 2025 examination papers · Theory of Cost · Microeconomics