Definition: a price function may be a mathematical formula wont to wont to chart how production expenses will change at different output levels. In other words, it estimates the entire cost of production given a selected quantity produced.

What Does Cost Function Mean?

Management uses this model to run different production scenarios and help predict what the entire cost would be to supply a product at different levels of output. the value function equation is expressed as C(x)= FC + V(x), where C equals total cost , FC is total fixed costs, V is variable cost and x is that the number of units.

Understanding a firm’s cost function is useful within the budgeting process because it helps management understand the value behavior of a product. this is often vital to anticipate costs which will be incurred within the next operating period at the planned activity level. Also, this enables management to guage how efficiently the assembly process was at the top of the operating period.

Example

The management of Duralex Companies, a manufacturer of toys, has asked for a replacement cost study to enhance next year’s budget forecasts. They pay rent of $300 a month and that they pay a mean of $30 a month for electricity. Each toy requires $5 in plastic and $2 in cloth.

A. what proportion will it cost them to manufacture 1200 toys annually?

B. what proportion will it cost them to manufacture 1500 toys annually?

First thing to try to to is to work out which costs are fixed and which of them are variable. Remember, fixed costs are incurred whether or not we manufacture, whereas variable costs are incurred per unit of production. meaning rent and electricity are fixed while plastic and cloth are variable costs.

Remember our cost function:

C(x) = FC + V(x)

Substitute the amounts.

A. At 1200

C(1,200) = $3,960* + 1,200 ($5 + $2)

C(1,200) = $ 12,360

Therefore, it would take $11,360 to produce 1,200 toys in a year.

B. At 1500

C(1,500) = $3,960* + 1,500 ($5 +$2)

C(1500)= $14,460

Therefore, it would take $13,460 to produce 1,500 toys in a year.

*FC = (300 +30) * 12 months (remember we are asked at an annual basis).

Thus, FC= $ 3,960