Thus reserve capacity is essentially a short run concept. Given this scale of the firm, it will produce up to the least cost per unit of output. For suitably small changes in input the ratio of the added cost to the added output measures the marginal cost. Several costs are variable in expansion but fixed in contraction. Thus economic costs include accounting costs plus implicit costs, that is, both explicit and implicit costs. This is through the insurance premia which transfer these risks to insurance companies.
In the banking system, money that gets deposited multiplies as it filters through the economy, going from depositor to borrower multiple times. The diseconomies of scale result from lack of coordination, inefficiencies in management, and problems in marketing, and increases in factor prices as the firm expands its scale. Other cost flows also emerge. When capacity is diminished the Central Bank can take steps to boost the money supply by adjusting the interest rate, judging how close an economy is operating to its full economic capacity helps make this decision. Implicit costs are also known as imputed costs. What will the banks' books look like after this purchase? Excess capacity means that insufficient demand exists to warrant expansion of output.
Hence, it is obvious that the concept of opportunity cost has special importance in management. For instance, new machinery can be installed by contracting fresh loans within a few months or a year. And they are above the average costs, where the latter rises. Further, as the firm expands, it enjoys internal economies of production. It seems plausible to assume that an initial phase of increasing returns to the variable inputs obtain. Assume that banks will make loans in the full amount of any excess reserves that they acquire and will immediately be able to eliminate loans from their portfolio to cover inadequate reserves. At first average total costs are high at low levels of output because both average fixed costs and average variable costs are large.
In such a graph, costs are measured on the Y axis and output is measured on the X axis. But if the production totally ceases, supervisors may be dispensed with, so that costs of supervision disappear with output. The administrative staff will be hired at such numbers as to allow some increase in the operations of the firm. When an increase in the production of one product results in an increase in the output of another product, such products are joint products and their costs are joint costs. The figure for Europe is not much different, for Japan being only slightly higher. Marginal cost is the cost of producing an additional unit of output, while incremental cost is defined as the change in cost resulting from a change in business activities.
Whatever is not required reserves is called excess reserves. The firm will, therefore, continue to produce within Q 1Q 2 reserve capacity of the plant, as shown in Figure 7. The remaining factors are variable whose supply is assumed to be known and available at fixed market prices. It also takes time to install fresh equipment or for old equipment to vary. A little too easy, right? This is natural because when constant total fixed costs are divided by a continuously increasing unit of output, the result is continuously diminishing average fixed costs.
Average Fixed Costs : This is the cost of indirect factors, that is, the cost of the physical and personal organization of the firm. Average Fixed Costs : From Fig. The firm has some largest capacity units of machinery which set an absolute limit to expansion of output in the short run. For example, the salary of a branch manager, when the branch is a costing unit, is a direct cost. This is illustrated in Fig. Thus, sunk costs are irrelevant for decision making as they do not vary with the changes expected for future by the management, whereas incremental costs are relevant to the management for business making.
Suppose, a producer has to decide whether he should produce black and white T. This flat stretch represents the built-in reserve capacity of the plant. Unlike the discomforts of a particular trade, which cannot be easily monetised, the discomfort of bearing predictable risks can be measured in money. The long- run average cost curve is tangent to different short run average cost curves. It means the cost of a plant at a price originally paid for it. So how do we calculate changes in the money supply? The money multiplier is the relationship between the reserves in a banking system and the money supply. Reserve Capacity — Traditional and Modern Views : As long as production can be increased without increasing the short run average variable cost, reserve capacity may be said to exist.
On the contrary, indirect costs may or may not be variable. Examples of current costs are wages, material and fuel costs, rent, interest and depreciation. There are various levels of management, each having a separate management technique applicable to a certain range of output. We mean current costs only, whenever we refer to the costs of the firm. Marshall called these variable costs as prime costs of production.