Last lecture, we studied the production curve, and learned about the law of diminishing marginal productivity- basically, that after a certain point (the inflection point), adding more variable factor (ie labour) will causes the marginal productivity to decrease.
Today, we're going to look at full cost curves, and discover how to derive them from the product curve.
It includes several factors:
Total Costs
Total Fixed Costs (overhead costs like rent, licenses and insurance: these do not change with quantity produced)
Total Variable Costs (costs like wages, supplies, etc. which change with the quantity produced)
Average Variable Costs: TVC/Q
Average Fixed Costs: TFC/Q
Average Total Costs: TC/Q
Remeber: Average costs are always a ray from the origin on the total cost curve.
Marginal Fixed Costs (Always zero)
Marginal Variable Costs: /\Total Variable Costs / /\Quantity Supplied
Total Variable Costs: /\Total Costs / /\Quantity Supplied
Remember: Marginal costs are always the slope of the derivative of the same point on the total cost curve.
Cost curves use the following formulas:
Total Costs = f(Q produced)
Total Costs = Total Variable Costs + Total Fixed Costs
Average Total Costs = Average Fixed Costs + Average Variable Costs.
TOTAL FIXED COSTS
These don't change as production increases, so the cost is constant throughout production
AVERAGE FIXED COSTS
These fall as production increases. This is called spreading overhead costs. Each additional unit produced has to cover a smaller and smaller portion of the original overhead costs.
TOTAL VARIABLE COSTS
The shape is due to specialization and saturation. Basically, remembering the production curve, we know that production initially increases at an increasing rate due to specialization and division of labour. This means that due to increased efficiency, the variable costs will not rise significantly for a particular range of output (because no new workers will be required to meet these production targets, so no extra wages will have to be paid).
As saturation occurs, we require more and more workers to be working to produce higher quantities of product. This causes our costs to rise, because each additional worker must be paid wages. Basically, we can infer that all of the cost changes seen on the variable cost curve are the result of production changes seen on the short run production curve.
AVERAGE VARIABLE COSTS
Similar to average production, only flipped upside down!
TOTAL COSTS-combining the two
As you can see, the average cost curve and the marginal cost curve are the rays and derivatives from the total cost curve.
The average cost and marginal cost curves are valley-shaped for the same reason that the average and marginal production curves are hill-shaped. When a firm is at capacity, it's average cost valley is at its lower point, and it's average producttion hill is at it's highet point.
Marginal costs intersects both the average costs and the average variable costs at their minimums.
AC is cup shaped
AVC is saucer shaped (they are lower than average costs because average costs also include average fixed costs)
MC is spoon shaped
PRODUCTION AND COST CURVES ARE VERY CLOSELY LINKED- costs are closely linked to production realities
There are two things which can shift the cost curve:
1: a change in input prices (varies directly with the cost curve. For an example, if I run a furniture factory, and the price of lumber goes up, my costs will all rise)
2: a change in fixed factor (this is a long-run planning decision), which can benefit or harm a firm, depending on production realities. Will a bigger lumber factory decrease average costs? It depends on how production goes- all we need to know is that it DOES change things!
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