Expenses that do not change with the number of units produced
Rent
Interest Payments
Secretaries
Property Taxes
Insu
ranc
e
Managers
Fixed Cost
Expenses that change with the number of units produced
Variable Cost
4
Some labor costs are fixed.
Management Salaries are a fixed cost, because they do not change with the
firm’s output.
Production Function
Quantity Produced (Q)
$ C
ost
s
Labor (L)
Quanti
ty P
roduce
d
(Q)
Cost Function
Fixed Costs: Do not change with Q
Q
FC =40000
Q=500 Q=10,000
$40,000
FC = 40000FC =40000
Q=0
Rent
Interest Payments
SecretariesProperty Taxes
Insu
ranc
e
ManagersFixed Cost
From MP to MCL Q MP VC MC0 0 01 5 5 50 10.002 15 10 100 5.003 30 15 150 3.334 50 20 200 2.505 67 17 250 2.946 82 15 300 3.337 95 13 350 3.858 107 12 400 4.179 117 10 450 5.0010 125 8 500 6.2511 131 6 550 8.3312 136 5 600 10.00
MP
Incr
ease
s
MC
Decr
ease
s
MP d
ecr
ease
s
MC Incr
ease
s
From MP to MCL Q MP VC MC0 0 01 5 5 50 10.002 15 10 100 5.003 30 15 150 3.334 50 20 200 2.505 67 17 250 2.946 82 15 300 3.337 95 13 350 3.858 107 12 400 4.179 117 10 450 5.0010 125 8 500 6.2511 131 6 550 8.3312 136 5 600 10.00
MP
Incr
ease
s
MC
Decr
ease
s
MP d
ecr
ease
s
MC Incr
ease
s
Wage =$50/da
y
Assume that labor is the
ONLY variable cost
1 worker = $50
2 workers = $100
3 workers = $150
From MP to MCL Q MP VC MC0 0 01 5 5 50 10.002 15 10 100 5.003 30 15 150 3.334 50 20 200 2.505 67 17 250 2.946 82 15 300 3.337 95 13 350 3.858 107 12 400 4.179 117 10 450 5.0010 125 8 500 6.2511 131 6 550 8.3312 136 5 600 10.00
MP
Incr
ease
s
MC
Decr
ease
s
MP d
ecr
ease
s
MC Incr
ease
s
Marginal CostL Q MP VC MC0 0 01 5 5 50 10.002 15 10 100 5.003 30 15 150 3.334 50 20 200 2.505 67 17 250 2.946 82 15 300 3.337 95 13 350 3.858 107 12 400 4.179 117 10 450 5.0010 125 8 500 6.2511 131 6 550 8.3312 136 5 600 10.00
MP
Incr
ease
sM
P d
ecr
ease
s
MC Incr
ease
s
MC = VC/Q
$50/5=$10$50/10=$5
$505units
$5010units
MC = wage/MP
$50/15=$3.3$50/20=$2.5$50/17=$2.9$50/15=$3.3$50/13=$3.8
MP Wage
From MP to MCL Q MP VC MC0 0 01 5 5 50 10.002 15 10 100 5.003 30 15 150 3.334 50 20 200 2.505 67 17 250 2.946 82 15 300 3.337 95 13 350 3.858 107 12 400 4.179 117 10 450 5.0010 125 8 500 6.2511 131 6 550 8.3312 136 5 600 10.00
MP
Incr
ease
s
MC
Decr
ease
s
MP d
ecr
ease
s
MC Incr
ease
s
MC = wage/MP
Increasing MP=Decreasing
MC
Wage is the same
Decreasing MP
=Increasing MC
Wage is the same
MC = VC/Q
From MP to MCL Q MP VC MC0 0 01 5 5 50 10.002 15 10 100 5.003 30 15 150 3.334 50 20 200 2.505 67 17 250 2.946 82 15 300 3.337 95 13 350 3.858 107 12 400 4.179 117 10 450 5.0010 125 8 500 6.2511 131 6 550 8.3312 136 5 600 10.00
MP
Incr
ease
s
MC
Decr
ease
s
MP d
ecr
ease
s
MC Incr
ease
s
MP
MP
Labor
Units of Output
MC
As th
e M
P incr
ease
s
The MC decreases
MC
As the MP decreases
The M
C incr
ease
s
When the MP is at its Maximum
The MC is at its Minimum
Diminishing Returns to Labor set in
Diminishing Returns to Labor set in
Q0
L0
From VC to TC: add FCL Q MP VC MC FC TC MC0 0 0 50,0001 5 5 50 10.00 10.002 15 10 100 5.00 5.003 30 15 150 3.33 3.334 50 20 200 2.50 2.505 67 17 250 2.94 2.946 82 15 300 3.33 3.337 95 13 350 3.85 3.858 107 12 400 4.17 4.179 117 10 450 5.00 5.0010 125 8 500 6.25 6.2511 131 6 550 8.33 8.3312 136 5 600 10.00 10.00 19
TC = FC + VC50,000 = FC + VC50,000 = FC + 0FC = 50,000
TC = FC + VC50,000 = FC + VC50,000 = FC + 0FC = 50,000
Variable cost of producing
zero units = 0
Total cost of producing zero units = 50,000
50,00050,00050,00050,00050,000
20
Marginal Cost
Cost of “the last” unit produced.– When one more unit is produced, the
fixed cost does not change.– Is the cost of labor, raw materials and
other variable expenses incurred when producing an additional unit.
Marginal Cost FormulaMC = TC/Q MC = (FC +VC) /Q
Because TC = VC when one more unit is produced, we can also write:
MC = VC/Q Marginal cost is the additional Variable
Cost of producing one more unit
FC = 0
MC is the slope of both the TC and the slope of the VC
MC = rise/runMC = slopeMC = rise/runMC = slope
TC and VC have the exact same slope
TC and VC have the exact same shape
22
L Q MP VC MC FC TC MC0 0 0 50,000 50,0001 5 5 50 10.00 50,000 50,050 10.002 15 10 100 5.00 50,000 50,100 5.003 30 15 150 3.33 50,000 50,150 3.334 50 20 200 2.50 50,000 50,200 2.505 67 17 250 2.94 50,000 50,250 2.946 82 15 300 3.33 50,000 50,300 3.337 95 13 350 3.85 50,000 50,350 3.858 107 12 400 4.17 50,000 50,400 4.179 117 10 450 5.00 50,000 50,450 5.0010 125 8 500 6.25 50,000 50,500 6.2511 131 6 550 8.33 50,000 50,550 8.3312 136 5 600 10.00 50,000 50,600 10.00
Total Cost = Fixed Cost + Variable Cost
23
L Q MP VC MC FC TC0 0 0 50,000 50,0001 5 5 50 10.00 50,000 50,0502 15 10 100 5.00 50,000 50,1003 30 15 150 3.33 50,000 50,1504 50 20 200 2.50 50,000 50,2005 67 17 250 2.94 50,000 50,2506 82 15 300 3.33 50,000 50,3007 95 13 350 3.85 50,000 50,3508 107 12 400 4.17 50,000 50,4009 117 10 450 5.00 50,000 50,45010 125 8 500 6.25 50,000 50,50011 131 6 550 8.33 50,000 50,55012 136 5 600 10.00 50,000 50,600
Total Cost = Fixed Cost + Variable Cost
L Q MP VC MC FC TC MC
0 0 0 5000
05000
0
1 5 5 505000
05005
0
2 15 10 1005000
05010
0
3 30 15 1505000
05015
0
4 50 20 2005000
05020
0
5 67 17 2505000
05025
0
6 82 15 3005000
05030
0
7 95 13 3505000
05035
0
8 107 12 4005000
05040
0
9 117 10 4505000
05045
0
10 125 8 5005000
05050
0
11 131 6 5505000
05055
0
12 136 5 6005000
05060
0
MC can be calculated using the VC or the
TC
TC50
VC50
MCVC/QMCVC/Q
MCTC/QMCTC/Q
10.0010.00
5.00 5.00
TC50
VC50
L Q MP VC MC FC TC MC
0 0 0 5000
05000
0
1 5 5 5010.0
05000
05005
010.0
0
2 15 10 100 5.005000
05010
0 5.00
3 30 15 150 3.335000
05015
0 3.33
4 50 20 200 2.505000
05020
0 2.50
5 67 17 250 2.945000
05025
0 2.94
6 82 15 300 3.335000
05030
0 3.33
7 95 13 350 3.855000
05035
0 3.85
8 107 12 400 4.175000
05040
0 4.17
9 117 10 450 5.005000
05045
0 5.00
10 125 8 500 6.255000
05050
0 6.25
11 131 6 550 8.335000
05055
0 8.33
12 136 5 60010.0
05000
05060
010.0
0
MCVC/Q MCTC/Q
Marginal Cost
Tells you how the Variable cost changes as more output is produced
It is the slope of the Variable Cost
26
MCVC/Q
Variable Cost
Output
Increasin
g functi
on
The MC decreases
MC
The M
C incr
ease
sSteps get smaller
MC
Steps
get
larg
er
Q VC0 05 50
15 10030 15050 20067 25082 30095 350107 400117 450125 500
131 550136 600
MC decrease
Steps get s
maller
MC In
crea
se
Steps
get
larg
erStarts at the Origin
Marginal CostTells you how the Variable cost changes as more output is produced
Tells you how the Total cost changes as more output is produced
Both the VC and the TC change by the SAME amount.
28
MCVC/Q
MCTC/Q
Total Costs
Output
Starts at FC
FC
The MC decreases
MC
The M
C incr
ease
sSteps get smaller
MC
Steps
get
larg
er
Starts at the Origin
TC
VC
TC has the same slope
(shape)as the VC
Average (per unit) Costs
TC = FC + VCTo get per unit costs, divide by Q (Units Produced)TC/Q = FC/Q + VC/Q
ATC = AFC + AVC
31
32
Fixed Costs
Fixed Costs do not change with the level of output (Q)
We show this by drawing a horizontal line.
Fixed Costs
Q
FC =40Kwhen Q=2
Q=2 Q=10
40K
FC = 40Kwhen Q=10
33
Average Fixed Costs
QQ=2 Q=10
4
20
AFC
Ave
rag
e F
ixed
Cost
AFC =20when Q=2
AFC = 4when Q=10
FC = 40Q = 2 AFC = 40/2 = 20
AFC = 40/10 = 4 AFC = 40/5 = 8
8
Q=5
Q = 5Q = 10
Even though FC remains the same: 40k
Even though FC remains the same: 40k
The Average Fixed Cost
Decrease as output increase
Variable Costs
Output
AVC = VC / Q
AVC = Slope of ray from
origin
AVC = rise / run
Minimum AVC
AVC
Q
VC
As Q increase, slope decrease: AVC decrease
Variable Costs
Output
AVC = Slope of ray from
origin
Minimum AVC
As Q increase, slope increase: AVC increase
AVC
TC
ATC = Slope of ray from
origin
Minimum ATC
As Q increase, (slope) ATC decrease
Output (Q)
ATC
ATC = TC / Q
As Q increase, (slope) ATC decreasereaches a minimum and then increase
37Q=2 Q=10
9
AVC = 1515
AVC
ATC = AVC + AFC
AFC
AFC =20
29
20
AFC = 44
ATC
19
AVC =9
ATC =29
ATC = 19
AVC
AFC
ATC
Q=2 Q=10
915
AVC
AV
C,
AF
C,
AT
C
29 ATC
19AFC
AFC AFCAFCDistance between the ATC and AVC =
AFC
Distance between the ATC and AVC = AFC
The Relationship between Average and Marginal costs
If MC > Average Cost, the Average Cost increase.If MC < Average Cost, the Average Cost decrease.If MC = Average Cost, the Average Cost does not increase or decrease: it is maximum.
39
AVC or ATCAVC or ATC
AVC or ATCAVC or ATC
AVC or ATCAVC or ATC
Q
MC
MC <
AVC
AVC
ATC
MC >
AVC,
MC <
ATC,
MC
> A
TC
,
MC = AVC, AVC minimum
MC = ATC, ATC minimum
AVC
decrease AVC in
crea
se
ATC
in
crea
se A
TC
decrease
42
MC cuts the ATC and the AVC at their MINIMUM points
ATC
,AV
C,
MC
AVC
MCATC
Reach Minimum at differentOutput levels
Min AVC
Min ATC
Min MC: Diminishing returns to labor set in
From Average Costs to Total Costs
ATC = TC/QAVC = VC/QAFC = FC/Q
TC =ATC x Q
VC = AVC x Q
FC = AFC x Q
Rearrange as
44
Per unit Costs
MC
AVC
ATC
ATCAVC
Q
VCTC AVC x Q = VC
AFC x Q = FC
ATC x Q = TC
AFC =ATC - AVC
FC
MC
Cost of producing the LAST unit
10
120
TC = 120*20FC = 120*(20-10)
VC = 120*10
For Q = 120
ATC = 20
AVC = 10
Cost of producing the120th unit
2020
AFC=20 -10= 10
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