The Costs of Production Fixed Costs Variable Costs and Total by liaoqinmei

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									                                                       The Costs of Production
                                                  • There are many different types of costs.
                                                  • Invariably, firms believe costs are too
                                                    high and try to lower them.

Costs
Part 2




     Fixed Costs, Variable Costs,                      Fixed Costs, Variable Costs,
     and Total Costs                                   and Total Costs
• Fixed costs are those that are spent            • Workers represent variable costs –
  and cannot be changed in the period of            those that change as output changes.
  time under consideration.
  • In the long run there are no fixed costs
    since all costs are variable.
  • In the short run, a number of costs will be
    fixed.




                                                                                               1
     Fixed Costs, Variable Costs,
     and Total Costs                             Average Costs
• The sum of the variable and fixed costs   • Much of the firm’s discussion is of
  are total costs.                            average cost.


             TC = FC + VC




     Average Costs                               Average Costs
• Average fixed cost equals fixed cost      • Average variable cost equals variable
  divided by quantity produced.               cost divided by quantity produced.


              AFC = FC/Q                                  AVC = VC/Q




                                                                                      2
        Average Costs                                          Marginal Cost
• Average total cost can also be thought                  • Marginal cost is the increase
  of as the sum of average fixed cost and                   (decrease) in total cost of increasing (or
  average variable cost.                                    decreasing) the level of output by one
                                                            unit.
                ATC = AFC + AVC                           • In deciding how many units to produce,
                                                            the most important variable is marginal
                                                            cost.




                                                               Graphing Cost Curves
           The Cost of Producing Earrings
  Output   FC    VC    TC    MC   AFC     AVC     ATC
                                                          • To gain a greater understanding of
    3      50     38    88   —    16.67   12.66   29.33
                                                            these concepts, it is a good idea to
    4      50     50   100   12   12.50   12.50   25.00
    9      50    100   150   —     5.56   11.11   16.67
                                                            draw a graph.
   10      50    108   158   8     5.00   10.80   15.80   • Quantity is put on the horizontal axis
   16      50    150   200   —     3.13    9.38   12.50     and a dollar measure of various costs
   17      50    157   207   7     2.94    9.24   12.18     on the vertical axis.
   22      50    200   250   —     2.27    9.09   11.36
   23      50    210   260   10    2.17    9.13   11.30
   27      50    255   305   —     1.85    9.44   11.30
   28      50    270   320   15    1.79    9.64   11.42




                                                                                                         3
                Total Cost Curves                                               Total Cost Curves
• The total variable cost curve has the                                       $400
                                                                                                                         TC
  same shape as the total cost curve—                                          350
                                                                                                                              VC

  increasing output increases variable                                         300
  cost.                                                                                TC = (VC + FC)




                                                                 Total cost
                                                                               250
                                                                               200           L
                                                                               150
                                                                               100          O
                                                                                                 M
                                                                                50                                             FC
                                                                                 0
                                                                                     2 4 6 8 10                  20      30
                                                                                                  Quantity of earrings




                                                                                Average and Marginal Cost
                Total Cost Curves                                               Curves

              $400
                                                    TC         • The marginal cost curve goes through
               350
                                                         VC      the minimum point of the average total
               300                                               cost curve and average variable cost
 Total cost




               250
                        TC = VC + FC
                                                                 curve.
               200            L                                • Each of these curves is U-shaped.
               150
               100           O
                                  M
                50                                        FC
                 0
                     2 4 6 8 10           20        30
                             Quantity of earrings




                                                                                                                                    4
     Average and Marginal Cost                  Downward-Sloping Shape of
     Curves                                     the Average Fixed Cost Curve
• The average fixed cost curve slopes      • The average fixed cost curve looks like
  down continuously.                         a child’s slide – it starts out with a
                                             steep decline, then it becomes flatter
                                             and flatter.
                                           • It tells us that as output increases, the
                                             same fixed cost can be spread out over
                                             a wider range of output.




     The U Shape of the Average                 The U Shape of the Average
     and Marginal Cost Curves                   and Marginal Cost Curves
• When output is increased in the short-   • The law of diminishing marginal
  run, it can only be done by increasing     productivity sets in as more and more
  the variable input.                        of a variable input is added to a fixed
                                             input.
                                            • Marginal and average productivities
                                              fall and marginal costs rise.




                                                                                         5
     The U Shape of the Average                       The U Shape of the Average
     and Marginal Cost Curves                         and Marginal Cost Curves
• And when average productivity of the     • The average total cost curve is the
  variable input falls, average variable     vertical summation of the average fixed
  cost rise.                                 cost curve and the average variable
                                             cost curve.




     The U Shape of the Average
     and Marginal Cost Curves                         Per Unit Output Cost Curves
• If the firm increased output                      $30
                                                     28
  enormously, the average variable cost              26
                                                     24
  curve and the average total cost curve             22
                                                     20
  would almost meet.                                 18
                                                     16
                                                     14                                          MC
                                             Cost




                                                     12                                          ATC
 • The firm’s eye is focused on average              10
                                                      8
                                                                                                 AVC
   total cost—it wants to keep it low.                6
                                                      4
                                                      2                                            AFC
                                                      0   2 4 6 8 10 12 14 16 18 20 22 2426 28 30 32
                                                                      Quantity of earrings




                                                                                                         6
                                                               The Relationship Between
         Per Unit Output Cost Curves                           Productivity and Costs
     $30
      28
                                                          • The shapes of the cost curves are
      26
      24
                                                            mirror-image reflections of the shapes
      22
      20
                                                            of the corresponding productivity
      18
      16
                                                            curves.
                                                  MC
  Cost




      14
      12                                          ATC
      10                                          AVC
       8
       6
       4
       2                                            AFC
       0   2 4 6 8 10 12 14 16 18 20 22 2426 28 30 32
                  Quantity of earrings




         The Relationship Between
         Productivity and Costs                                                                 14                MC
                                                                            Costs per unit




                                                                                                12                     AVC
                                                                                                10
• When one is increasing, the other is                    The                                    8
                                                                                                 6
  decreasing.                                             Relationship                           4
                                                                                                 2

 • When one is at a maximum, the
                                                          Between                                0   4 8 12 16 20 24 Output
   other is at a minimum.                                 Productivity                           7
                                                                            Output per worker




                                                                                                 6
                                                          and Costs                              5
                                                                                                        A
                                                                                                 4                  AP of
                                                                                                 3                workers
                                                                                                 2
                                                                                                 1            MP of workers
                                                                                                 0   4 8 12 16 20 24 Output




                                                                                                                              7
     Relationship Between Marginal
                                                    Relationship Between Marginal
     and Average Costs                              and Average Costs
• The marginal cost and average cost           • Marginal cost curves always intersect
  curves are related.                            average cost curves at the minimum of
  • When marginal cost exceeds average cost,     the average cost curve.
    average cost must be rising.
  • When marginal cost is less than average
    cost, average cost must be falling.




     Relationship Between Marginal                  Relationship Between Marginal
     and Average Costs                              and Average Costs
• The position of the marginal cost            • To summarize:
  relative to average total cost tells us
  whether average total cost is rising or          If MC > ATC, then ATC is rising.
  falling.                                         If MC = ATC, then ATC is at its low point.
                                                   If MC < ATC, then ATC is falling.




                                                                                                8
                    Relationship Between Marginal                 Relationship Between Marginal
                    and Average Costs                             and Average Costs
• Marginal and average total cost reflect                    • As long as average variable cost does
  a general relationship that also holds                       not rise by more than average fixed
  for marginal cost and average variable                       cost falls, average total cost will fall
  cost.                                                        when marginal cost is above average
                If MC > AVC, then AVC is rising.               variable cost,
                If MC = AVC, then AVC is at its low point.
                If MC < AVC, then AVC is falling.




                    Relationship Between Marginal
                    and Average Costs

                $90
                    ATC                   MC
                 80
                 70    Area A      Area C
                 60 AVC Area B
   Costs per unit




                 50                           ATC
                 40                          AVC
                 30                B
                 20
                               A
                 10 MC        Q0 Q1
                  0
                     1 2 3 4 5 6 7 8 9 Quantity




                                                                                                          9

								
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