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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