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

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• pg 1
```									                                                       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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