Answer to Question #41860 in Macroeconomics for Rojina

Question

“Cost function expresses the relationship between the cost and its determinants.” Discuss this statement giving examples from any firm of your choice.

Answer 1

Cost function expresses the relationship between cost and its determinants such as the size of plant, level of output, input prices, technology, managerial efficiency, etc. In a mathematical form, it can be expressed as, C = f (S, O,
P, T, E…..)
Where, C = cost (it can be unit cost or total cost)
S = plant size
O = output level
P = prices of inputs used in production
T = nature of technology
E = managerial efficiency

Determinants of Cost Function
The cost of production depends on many factors and these factors vary from one firm to another firm in the same industry or from one industry to another industry. The main determinants of a cost function are:

a) plant size
b) output level
c) prices of inputs used in production,
d) nature of technology
e) managerial efficiency

For example, if consider Ford Company, the higher is the plant size and the output level, the lower will be the cost, as there will be economies on scale, as the fixed costs per unit will decrease. If the price for aluminium or steel will decrease, the total cost of a car produced will be lower. If there are some improvements in technology of making some parts of a car, the total cost will also decrease, as the cost of producing this parts will increase, or the use of these parts will be much more effective.