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Concept Of Factor Cost

 Concept of Factor Cost

      The total cost of a factor TFC is the expenditure incurred by a firm in hiring or buying that factor. It is further divided into average and marginal factor cost.

  1. Average Factor Cost – AFC is the per unit cost of variable factor employed by a firm. It is obtained by dividing total factor cost by the units of the factor employed, i.e.
  2. AFC =                         TFC
                            Units of Factor Employed

  3. Marginal Factor Cost – MFC is the addition to the total factor cost by hiring or purchasing an extra unit of that factor:

MFC = TFCn – TFCn-1

Let us see an illustration which explains the aspects of Factor Cost.

Illustration 2

Given tablet represents the units of factor service and the price of factor. You have to determine the following.

  1. Total Factor Cost
  2. Average Factor Cost
  3. Marginal Factor Cost

Units of Factor Service

Price of Factor
Value in $

1

8

2

8

3

8

4

8

5

8

Solution

Factor Cost

Units of Factor Service

Price of Factor
Value in $

Total Factor Cost
Value in $

Average Factor Cost
Value in $

Marginal Factor Cost
Value in $

         

(a)

(b)

(c) = (a x b)

(d) = (c / a)

(e) = (c – cn-1)

1

8

8

8

-

2

8

16

8

8

3

8

24

8

8

4

8

32

8

8

5

8

40

8

8

Association between AFC and MFC

The relation between AFC and MFC is different in a perfectly competitive factor Market and monopolistic factor market. In a perfectly competitive factor market, the price of that factor is determined by its demand and supply. The price of that factor is given for the firm at which it buys as many units as are required by it.

Hence the supply of that factor is perfectly elastic at the given price and the supply curve of the factor of the straight line paralleled to the X-axis. As the price of the factor is assumed to be given and constant, hence its average factor cost and marginal factor cost equal the price of the factor i.e. AFC = MFC = Price of the factor.

This is represented in the below pictorial representation and in the illustration 2 of the columns (b), (d) and (e).

The supply curve of factor is P = AFC = MFC at which its OQ quantity is bought by the firm. In a monopolistic (imperfect) factor market, a firm had monopsony, being the sole buyer of a factor. So its factor curve AFC is upward inclined to the right and its MFC curve is above its AFC curve as represented in the below diagram.

            It means that if the firm wants to employ more units of that factor say for instance labour, it will have to spend more that is wage not only on additional units but on its all units, workers.

            As a result, MFC of that factor will be more than its AFC (Actual Cost). Hence the MFC curve will be above its AFC curve.

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