4/11/2013

Analysis of Costs
EC 102. Basic Economics, • Total Cost (TC)
- lowest total expense needed to produce
Agrarian Reform, and Taxation
each level of output
- relationship between output and total
Lecture 9 cost:
…as output rises, total cost rises
Firm Behaviour 2 - more inputs are needed for more
output thus the cost of production
increases

NAS Cabiles 1 NAS Cabiles 2

Analysis of Costs Analysis of Costs

•Components of Total Cost:
1. Fixed Cost (FC)
- a.k.a. overhead costs/sunk
costs/maintenance costs
- expenses made to establish the firm &
keep it running
- incurred even if the output is zero or
otherwise
- cannot be recovered when the firms
shuts down
NAS Cabiles
•Components of Total Cost:
2. Variable Cost (VC)
- expenses that change together with
output
- i.e. cost of materials or inputs used to
make a product
- if output of zero, variable cost may be
zero

Total Cost (TC) = Fixed Cost (FC) + Variable
Cost (VC)
3 NAS Cabiles 4

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Analysis of Costs Analysis of Costs

• Other important Cost Concepts • Other important Cost Concepts
a. Marginal Cost (MC) c. Average Fixed Cost (AFC)
- extra or additional cost of producing one - Fixed cost over the total amount of output
extra unit of output - AFC = FC ÷ Q
- gives an idea if additional production is - gives an idea if a firm is getting “returns”
worth pursuing or not from its initial investment
b. Average Total Cost (ATC) d. Average Variable Cost (AVC)
- total cost over the total amount of output - Variable cost over the total amount of output
(Q) - AVC = VC ÷ Q
- ATC = TC ÷ Q - gives an idea of the level of output (Q) at
- gives an idea if a firm profits in its production which the firm can profit the most
of an output by comparing ATC with P NAS Cabiles 6

Analysis of Costs Analysis of Costs

300
Fixed Variable Total Marginal Ave Total Average Average
Quantity
Cost Cost Cost Cost Cost Fixed Cost Variable Cost Total Cost
(Q)
(FC) (VC) (TC) (MC) (ATC=TC/Q) (AFC=FC/Q) (AVC=VC/Q)
250
•VC pushes up Curve
the TC while
0 55 0 55 - - - - 200
the FC remains
Total Cost (TC)

1 55 30 85 30 85 55 30
150
stable
Variable
2 55 55 110 25 55 27.50 27.50
Cost Curve
100

3 55 75 130 20 43.33 18.33 25

50
4 55 105 160 30 40 13.75 26.25 Fixed Cost
Curve
5 55 155 210 50 42 11 31 0
0 1 2 3 4 5 6

Quantity (Q)
6 55 225 280 70 46.67 9.17 37.50
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Analysis of Costs Analysis of Costs

80 90
• MC is “U-shaped” or Average
70 initially declines then 80
Total Cost
increases Marignal Curve
70 Marginal
60 Cost Curve
• Due to: Cost Curve

Average Costs (AC)

Marginal Cost (MC)

60
50
1. Full use of 50
Average
40 capital/economies of scale
Fixed Cost
and the depreciation that 40

30
follows. 30
Average
20
2. Law of Diminishing 20 Variable
Returns Cost
10
10

0 0
1 2 3 4 5 6 7 1 2 3 4 5 6 7

Quantity Quantity (Q)

Analysis of Costs Analysis of Costs

• Observations on Average Costs & Marginal • Shut-down Condition
Cost: Q: When does a firm shut-down?
1. AFC declines as more and more output is Points to consider:
produced. • A shut-down is a halt in production of output by a
- FC is “distributed” or “diffused” among firm temporarily.
• Profit = Revenues (R) – Total Cost (TC)
more units of output Profit = (P X Q) – (FC+VC)
2. MC = ATC at ATC’s minimum point. • A firm does not shut down if it profits or Profit > 0.
• A firm shuts down if it doesn’t profit or Profit ≤ 0.
• When a firm shuts down, it loses or cannot recover
its FC.

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Analysis of Costs
• Shut-down Condition is:
Profit ≤ 0
Revenues – Total Cost ≤ 0
(P X Q) – (FC + VC) ≤ 0
(P X Q) – (VC) ≤ 0
(P X Q) ≤ VC
P ≤ VC÷Q
P ≤ AVC
Shut-down Condition

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