Total cost includes all cash payments made to hired factors of production and all cash charges imputed for the use of the owner’s factors of production in acquiring or producing a good or service. Thus, total cost of a firm is the sum total of the explicit plus implicit expenditures incurred for producing a given level of output. For example, a shoe maker’s cost will include the amount he spends on leather, thread, rent for his workshop, wages, interest on borrowed capital, salaries of employees, etc., and the amount he charges for his services and his own funds invested in the business.
Average cost is the cost per unit of output assuming that production of each unit of output incurs the same cost. That is, it is obtained by dividing the total cost by the total quantity produced. If TC=100 and X=10, AC = 10.
Marginal cost is the extra cost of producing one additional unit. At a given level of output, one examines the additional costs being incurred in producing one extra unit and this yields the marginal cost. For example, if the total cost of a firm is Rs 5,000 when it produces 10 units of a good but when 11 units of the good are produced, it increases to Rs 5,300 then the marginal cost of the eleventh unit is Rs 5,300 – 5,000 = Rs 300. In other words, marginal cost of nth units (MCn) is the difference between total cost of nth unit (TCn) and total cost of n-1th unit (TCn-1).
MCn = TCn – TCn–1
The total cost concept is useful in break-even analysis and in finding out whether a firm is making profits or not. The average cost concept is significant for calculating the per unit profit of a business concern. The marginal and incremental cost concepts are needed in deciding whether a firm needs to expand its production or not. In fact, the relevant costs to be considered will differ from one situation to the other depending on the problem faced by the manager.
Managerial economics devotes a great deal of attention to the behaviour of costs. Total cost varies directly with output. The more output a firm produces, the higher will be its production cost and vice versa. This is because increased production requires increased use of raw materials, labour, etc., and if the increase is substantial even fixed inputs like plant and equipments and managerial staff may have to be increased. The relationship between cost and output is rather important.