Concepts
- Total Cost (TC = FC + VC)
- Fixed Costs
- Variable Costs
- VC are Only Costs that Change
- ΔVC = ΔTC = MC
- Marginal Cost (MC = ΔTC / ΔQ)
- MC = Slope of TC
- Emphasize the Link Between MC and ΔVC
- Average Total Cost (ATC = TC/Q) or (ATC = AFC + AVC)
- Average Fixed Cost
- AFC Continuously Decreases as Output Increases
- Average Variable Cost
- Average Fixed Cost
- “U-Shape” of Per-Unit Cost Curves in Short-Run
- Increasing Marginal Returns (Increasing Marginal Product)
- Specialization
- AFC Decreases as Output Increases
- ↑ Efficiency
- Decreasing Marginal Returns (Decreasing Marginal Product)
- Law of Diminishing Marginal Returns (LDMR)
- ↓ Efficiency
- Increasing Marginal Returns (Increasing Marginal Product)
- Graphs of Total Costs and Per-Unit Costs
- Total Cost Graph
- FC Horizontal Because They’re Constant
- VC and TC Increase as Output Increases
- VC = 0 at Zero Output (No Workers, No Taco Shells)
- FC = TC at Zero Output (Still Have to Pay Rent)
- Per-Unit Cost Graph
- MC Drawn First Because it Changes First
- MC < ATC, Pulls ATC Down
- MC > ATC, Pulls ATC Up
- MC = ATC at the Minimum of ATC
- MC and AVC Work the Same as MC and ATC
- AVC Gets Closer to ATC as Output Increases (↓AFC)
- Shifting MC
- Total Cost Graph
- In-Depth Calculations of These Measurements (Backdoor Math)
- Use Average Values and Q to Back into the Total Value
Overview
Cost analysis is all about measuring the cost of producing output. There are 3 general calculations we observe when measuring costs: total, marginal, and average costs. Total cost equals fixed costs + variable costs. Fixed costs, like rent, are independent of output. They do not change as output changes. Variable costs, like labor, do change as output changes. At zero output a firm does not have to pay any variable costs because they don’t have to hire any workers. However, at zero output they still have to pay rent until their lease expires. This is why at zero output, TC is entirely comprised of FC. Since fixed costs exist, we know this is short-run cost analysis. Marginal cost is the additional cost of producing one more unit of output. It is the incrimental change to total cost. Again we see a marginal value that is the slope of it’s respective total. Since variable costs are the only costs that change, the change in variable cost is the marginal cost. Average total cost is the cost per-unit. Marginal cost changes first, then average total cost responds. Average total cost is also calculated by adding AFC + AVC. Average fixed cost keeps getting smaller as output increases and average variable cost has a “u-shape.” The u-shape of short-run cost curves is the result of specialization when the first few workers are hired and the law of diminishing marginal returns when workers start getting in each other’s way. Graphing cost analysis can be a bit complex because of the many details involved. In this lesson, we will learn all the details pertaining to graphing total costs and per-unit costs. The last part of this lesson deals with the difficult math questions that can be asked about cost analysis. We learn how to use “backdoor math” to take data given in the problem and back our way into the correct answer.
Materials
Lecture
Per-Unit Costs Graph Video
Per-Unit Production and Per-Unit Costs Graph Video
Short-Run Cost Analysis Lecture Video
Quiz
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