This lesson is divided in three parts:
A very important concept to begin with, the difference between explicit cost and implicit cost. Explicit costs are visible costs that are commonly used in our daily lives such as rent, salaries, etc. There is an actual payment that takes place, these are the costs that accountants use in their books. Economists add implicit costs to this list, the opportunity costs. These are costs that are not as evident, for example if a student gives up a salary of $10,000 per year to start a business the student has to consider the salary as an implicit cost. In general any opportunity cost should be considered an implicit cost. The sum of implicit and explicit cost gives economists the total total cost of production. By definition this cost will be higher than what the accountants would reflect. (Accountants are not as clever as economists! :). The definitions in this tutorial are very brief, for a more complete definition please click on: complete definitions
The total cost curves show what the total cost of production is at any level of production. There are three cost curves to analyze: total fixed, total variable and total cost. Fixed cost doesn't change with production, the number of units produced doesn't affect this value. Examples of this cost are property taxes and rent (the rent at George's Burgers remains the same regardless of the number of burgers cooked!) In this tutorial we will deal with a firm that makes pants, our company will be called Funky Pants :) Assume it is a poor Palomar College student, a fashion design major, who works at home and is renting a sewing machine for $36/month. Rent is the only fixed cost :)
Below is a chart with the number of units produced and next to it the graph that reflects this data.
Short-Run Production Costs of Producing Funky Pants
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 Remember that to graph the table you start with 0 pants and $36, then 1 pant and $36, etc. Since the cost doesn't change the line is horizontal. As the cost goes up or down the cost curve will also go up or down. This is probably the simplest of all the cost curves! |
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The next cost curve is the Total Variable Cost which changes with the number of units produced, that is to say the higher the number of pants produced the larger the variable costs. Saw more pants and you need more cloth, more zippers, more buttons, etc. The production costs tend to be steep at first, (for example, the period of time needed to learn the job) then as production increases costs decrease. Economists call the former "increasing costs at an increasing rate". Nice, ha? Think about the first time you did a job, how efficient were you? However as time progressed you got better at it. This is reflected in the graph below: the line starts steep and then flattens out a bit, ("costs increasing at a decreasing rate") then costs start increasing again. (back to "costs increasing at an increasing rate"!). The shape of the Total Variable Cost shows this very important concept in economics, "diminishing marginal returns". As more and more workers (variable cost) are hired to work with a machine (fixed input) the quantity and quality of production tends to decrease. When the first units are produced, the workers are not very efficient; they are learning their respective tasks. After a period of time the workers become very efficient and highly productive. If production increases further they reach capacity and the costs start rising rapidly (say to buy a new machine). This is what happens when workers start working overtime, costs are increasing rapidly.
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| When the variable costs increase, for example if Funky Pants has to pay more for the cloth they use to produce their pants, the total variable cost curve will shift up. Click the button and you'll see! |
Finally we have the combination of the two cost curves above, the total cost curve. Adding the two figures in the first table (total fixed cost plus total variable cost) we have the total cost. See Table below:
| Quantity | Total Fixed Cost | Total Variable Cost | Total Cost | Typically higher costs will shift the curve up, roll your mouse over the chart and you will see the new graph with higher costs! | |||||||||||||||||||||||||||||||||||||||||||||
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Place your mouse on top of the picture below and the graph shows the same effect as as above with the new costs reflected on the table:
Summary
The total cost tables and curves provide information regarding fixed costs, variable costs and the combination: total cost of production. The fixed cost remains the same over a period of time, it does not change with production such as rent. Variable costs increase as more production takes place, however the rate of increase changes given the number of machines and the productivity of the workers, an example of this is the quantity of clothing used in making pants. Graphically the fixed cost is a horizontal line, while the variable cost changes slope according to the rate of increase in the cost function. Those students that have taken calculus may think in terms of derivatives as the rate of change in the costs of production. The combination of fixed cost and variable cost result in the the total cost, graphically it is represented by a curve similar to the variable cost with the fixed cost added to it. This results in a parallel shift upwards of the total variable cost.
| Total Fixed cost | Total Variable Cost | Total cost |
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Have you learned all there is to know about the total cost curves? Check your knowledge with the worksheets below:
1) Complete the table below by calculating the missing data:
| Quantity | Total Fixed Cost | Total Variable Cost | Total Cost |
| 0 | 0 | 300 | |
| 1 | 300 | 75 | |
| 2 | 150 | 450 | |
| 3 | 600 | ||
| 4 | 300 | 500 |
2) Graph the cost curves for the table above.
3) Explain what would happen if fixed cost went up by $100.
4) Explain what would happen if variable cost went up by $25 at every level of production starting with unit 1.
5) Graph the total variable cost and total cost curves from number 4 above.
Yeahoo! This is the end of the total cost curves tutorial.
The Average Fixed Cost is the first cost per unit curve that we shall analyze. As the name implies it is calculated by using the total fixed cost discussed previously and determining the average cost per unit. Since we start with a the toal fixed cost and spread this number amongst an increasing number of units, the AFC becomes smaller and smaller. Below is a table and a graph of the AFC:
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 As you can see from the graph above, the larger the number of units the lower the average cost per unit. Check column F! Starts at $36 at 1 unit (there are no averages at 0 units) and goes to $3.60 at the 10th unit. Visualize what would happen if you produce a million units! Suppose the cost goes up? What do you think would happen? Try to sketch it in a piece of paper or in your mind, and then compare with the movie below.
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Click on the button above and you can see how the AFC curve moves up.
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Coming soon!
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