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| | Let's pause for a moment and review some concepts from the last class. Imagine you are the owner of a firm. You want to understand all your costs. There are seven basic types of costs for a firm, also known as "cost measures: | | Let's pause for a moment and review some concepts from the last class. Imagine you are the owner of a firm. You want to understand all your costs. There are seven basic types of costs for a firm, also known as "cost measures: |
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| − | * marginal cost | + | * marginal cost (MC) |
| − | * total cost | + | * total cost (TC) |
| − | * average total cost | + | * average total cost (ATC) |
| − | * fixed cost (or total fixed cost) | + | * fixed cost (FC, which is also the total fixed cost because there is nothing to sum) |
| − | * average fixed cost | + | * average fixed cost (AFC) |
| − | * variable cost (or total variable cost) | + | * total variable cost (TVC) |
| − | * average variable cost | + | * average variable cost (AVC) |
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| − | The '''''average''''' of a type of cost is simply the '''''total''''' of that cost divided by the output produced, also known as "Q". | + | The '''''average''''' of a type of cost is simply the '''''total''''' of that cost divided by the output (number of units) produced by the firm, also known as "Q". Stated another way, the average of a type of cost is the total cost ''per unit'' produced by the firm. |
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| | Hence: | | Hence: |
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| − | :ATC = TC / Q, where ATC is the abbreviation for "average total cost," and TC is the abbreviation for "total cost." | + | :ATC = TC / Q, where ATC is the abbreviation for "average total cost," and TC is the abbreviation for "total cost," and Q is output. |
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| | + | :AFC = FC / Q, where AFC is the abbreviation for "average fixed cost," and FC is the abbreviation for "fixed cost," and Q is output. |
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| | + | We can also relate the different costs by using simple reasoning. The total cost is, of course, all the costs added together. It is the sum of the fixed cost plus the variable cost: |
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| | + | :TC = FC + TVC |
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| | + | Exam questions can require manipulation of the above equations. For example, a question can give you the total cost as $1000 and the fixed cost as $700, and then ask you what the total variable cost is. Simply use the equation above: |
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| | + | :TC = FC + TVC, and thus TVC = TC - FC, and hence TVC - $1000 - $700 = $300 |
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| | + | Next suppose a question states that the total cost (TC) is a function of output (Q) as follows: |
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| | + | :TC = 5Q + 200 |
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| | + | The question may then ask, what is the fixed cost (FC)? The answer requires realizing that the fixed cost is defined as the cost when the output (Q) is 0. Plug in 0 into the above equation and solve for FC: |
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| | + | :FC = TC(when Q=0) = 5*0 + 200 = $200 |
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| | + | Often an exam question will give you a table of units produced in the first column, and total costs in the second column, and then ask you to use the table to calculate all seven of the above costs. Here is a simple guide: |
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| | + | *FC is the cost when Q=0 |
| | + | *AFC is FC/Q, usually using the maximum Q in the table |
| | + | *TC is the total cost for each Q, usually using the maximum Q in the table |
| | + | *ATC is TC/Q |
| | + | *TVC is TC - FC |
| | + | *AVC is TVC/Q |
| | + | *MC is the difference in cost between the last good produced and the one before it |
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| | == More == | | == More == |