# Understanding Costs

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```					Understanding Short
Run Costs
Short run costs
Fixed Costs
Variable Costs
AC, MC and AVC
Fixed Costs

¢   In the short run, because at least one
factor of production is fixed, output can
be increased only by adding more
variable factors
¢   Hence we make a distinction between
fixed and variable costs
Fixed factor inputs
Fixed Costs
¢   Fixed costs
l   These do not vary directly with the level of
output i.e. they are treated as independent of
production
l   Examples of fixed costs include the rental
costs of buildings, the costs of leasing or
purchasing capital equipment such as plant
and machinery, the costs of full-time
contracted salaried staff, the costs of meeting
interest payments on loans, the depreciation of
fixed capital (due solely to age) and also the
Examples of fixed costs for
Fixed Cost Curves

Costs

Total Fixed Cost

Output
Fixed Cost Curves

Costs

Total Fixed Cost

Average Fixed Cost

Output
Variable Costs
¢   Variable costs are business costs that vary
directly with output
¢   Examples of variable costs include the costs of
intermediate raw materials and other
components, the wages of part-time staff or
employees paid by the hour, the costs of
electricity and gas and the depreciation of
capital inputs due to wear and tear.
¢   Total variable cost rises as output increases
¢   Average variable cost (AVC) = total variable
costs (TVC) /output (Q)
Marginal Cost (MC)
¢   Marginal cost is the change in total costs from
increasing output by one extra unit.
¢   The marginal cost of an extra unit of output is
linked with the marginal productivity of labour
l   If marginal product is falling, assuming the cost
of employing extra units of labour is constant the
extra costs of these units of output will rise
l   There is an inverse relationship between
marginal product and marginal cost.
The Marginal Cost Curve

Costs                  Marginal
Cost (MC)

Output
An increase in marginal costs
MC2
Costs
MC1

Output
Variable Cost Curves

Costs
Marginal Cost
Average
Variable Cost

Output
An Increase in Variable Costs
MC2

Costs                           AVC2

MC1
Average
Variable Cost

Output
Family of short run cost
curves
Costs
MC        ATC

AVC

Output
A change (fall) in fixed costs

Costs
MC         ATC1

ATC2

AVC

Output

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 views: 0 posted: 7/2/2013 language: English pages: 22