3.3.
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28/04/23
Fixed costs
Fixed costs are business expenses
that don’t vary directly with the
level of output
i.e. they are treated as independent
of level of production
Average fixed cost decreases as
production increases
Variable costs
Variable costs are business expenses that don’t vary directly with the
level of output
i.e they are dependent on the level of production
Examples include raw materials, delivery costs, commissions
Total and average costs
Total cost made up of 2 parts:
- TFC which doesn’t vary with output
- TVC which changes directly with output
Average Total cost= Average fixed cost + Average variable cost
Average (total) cost is total costs/output
Complete the table
Output Total fixed Average Total Average Total cost Average total
costs fixed costs variable variable cost cost
costs
0 200 200 0 0 200 0
1 200 200 200 200 400 400
2 200 100 300 150 500 250
3 200 66.67 600 200 800 266.67
4 200 50 1200 300 1400 350
5 200 40 2000 400 2200 440
Formulae (costs)
Total cost (TC): The cost of producing a given level of output: fixed + variable costs
Total fixed cost (TFC) : Costs that do not change with output and remain constant e.g. rent, machinery
Total variable cost (TVC): Costs that change directly with output e.g. materials
Average (total) cost (ATC): total costs output
Average fixed cost (AFC): total fixed cost output
Average variable cost (AVC): total variable cost output
Marginal cost (MC): The extra cost of producing one extra unit of a good: total cost of producing N goods -
total cost of producing (N-1) goods OR change in total cost change in output
Marginal cost
Marginal cost is the cost of producing an additional unit of output
Can be calculated as difference in total cost from producing one
additional unit of output
Change in total cost / change in output
Marginal cost table (Change in TC/Change in
output
Output Total Cost Marginal cost
0 200
200
1 400
100
2 500
300
3 800
600
4 1400
800
5 2200
The economic cost of production for a
firm is the opportunity cost of
production ; the value that could have
been generated had the resources
been employed in their next best use.
Labour Output TVC TFC TC AVC AFC ATC MC
1 20 200 1000 1200 10 50 60
5.9
2 54 400 1000 1400 7.41 18.52 25.93
4.3
3 100 600 1000 1600 6 10 16
3.9
4 151 800 1000 1800 5.30 6.62 11.92
4.3
5 197 1000 1000 2000 5.08 5.08 10.16
6.1
6 230 1200 1000 2200 5.22 4.35 9.57
9.5
7 251 1400 1000 2400 5.58 3.98 9.56
22.2
8 260 1600 1000 2600 6.15 3.85 10
Diagram (Average marginal costs short run)
Average total cost and average
variable cost are u shaped
Marginal cost curve is a tick shape
Marginal cost cuts average variable
costs at its minimum point from
below
The Y axis is costs and X axis is
output/quantity
Diagram analysis
- The average fixed cost curve (AFC) starts high because the whole fixed
costs are being divided by a small output.
- As output is increased, AFC falls as the same amount is divided by a
larger number.
- The average total cost curve (AC/ATC) is U-Shaped due to the law of
diminishing marginal productivity.
- Costs initially fall as machinery is used more efficiently but as production
continues to expand, efficiency falls as machinery is overused.
Diagram analysis cont.
The average variable cost curve (AVC) is also U-Shaped
but it gets closer to ATC as output increases since AFC gets smaller.
The marginal cost (MC) will also be U-Shaped due to the law of
diminishing marginal productivity.
It will initially fall as the machines are used more efficiently but will
rise as production continues to rise.
Diagram analysis cont.
The marginal cost line will always cut the AC line at the lowest point on the AC curve: if MC
is below AC, then AC will continue to fall since producing one more costs less than the
average so the average falls; but if MC is above AC, then AC will rise. Marginal costs can be
rising whilst AC is still falling, as long as MC is still below AC.
Each firm will have a different total cost curve. If average costs are constant, the line would
be a straight diagonal line beginning at the origin. When output is 0, fixed costs are equal
to total costs since there are no variable costs. Average costs can be worked out from the
total cost curve: at point A, average costs are C/D whilst at point B, average costs are E/F.
Average costs at B are lower than at A, since the gradient of A is steeper than B. The
tangent to the total cost curve is marginal cost.
Diagram (Total costs)
Black line is total costs
Green line is total variable costs
Red line is total fixed costs
SO total costs = fixed costs +
variable costs
Law of diminishing returns (productivity)
If a factor of production is fixed, this will affect the business if it decides to expand
More workers can be added relatively easily and this will see an increase in
production as machinery is used more efficiently.
However, it will take a long time for the factory to expand and adding more labour
will mean that they will have less and less impact on the amount produced as they
get in the way and have no machines to use.
This is called the Law of Diminishing Returns or diminishing marginal
productivity.
Diminishing marginal productivity means that if a variable factor is increased when
another factor is fixed, there will come a point when each extra unit of the variable
factor will produce less extra output than the previous unit.
Marginal output will decrease as more inputs are added in the short run. This will
mean that the marginal cost of production will rise.
