Fixed and Variable Costs

 Fixed costs (FC) do not vary with the quantity of

output produced.
 For Farmer Jack, FC = $1000 for his land
 Other examples:
cost of equipment, loan payments, rent
 Variable costs (VC) vary with the quantity
produced. It can increase or decrease according
to the units to be produced.
 For Farmer Jack, VC = wages he pays workers
 Other example: cost of materials
 Total cost (TC) = FC + VC
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EXAMPLE 2: Costs
$800 FC
Q FC VC TC $700 VC
TC
0 $100 $0 $100 $600
1 100 70 170 $500

Costs
2 100 120 220 $400
3 100 160 260
$300
4 100 210 310
$200
5 100 280 380
$100
6 100 380 480
$0
7 100 520 620 0 1 2 3 4 5 6 7
Q
2
EXAMPLE 2: Marginal Cost
$200
Q TC MC Recall, Marginal Cost (MC)
is $175
the change in total cost from
0 $100
$70 producing
$150 one more unit:
1 170
50 $125 ∆TC
MC =
Costs
2 220 $100 ∆Q
40
3 260 Usually,
$75 MC rises as Q rises, due
50 to diminishing marginal product.
4 310 $50
70 Sometimes (as here), MC falls
5 380 $25
100 before rising.
6 480 $0
140 (In other0 examples,
1 2 3 MC 4 may
5 6be 7
7 620 constant.) Q
3
EXAMPLE 2: Average Fixed Cost

Q FC AFC $200
Average fixed cost (AFC)
0 $100 n/a
is$175
fixed cost divided by the
quantity
$150 of output:
1 100 $100
AFC
$125 = FC/Q

Costs
2 100 50
$100
3 100 33.33
Notice
$75 that AFC falls as Q rises:
4 100 25 The
$50firm is spreading its fixed
5 100 20 costs over a larger and larger
$25
number of units.
6 100 16.67 $0
7 100 14.29 0 1 2 3 4 5 6 7
Q
4
EXAMPLE 2: Average Variable Cost

Q VC AVC $200
Average variable cost (AVC)
is$175
variable cost divided by the
0 $0 n/a
quantity
$150 of output:
1 70 $70
AVC
$125 = VC/Q

Costs
2 120 60
$100
3 160 53.33 As$75
Q rises, AVC may fall initially.
4 210 52.50 In most cases, AVC will
$50
eventually rise as output rises.
5 280 56.00 $25
6 380 63.33 $0
7 520 74.29 0 1 2 3 4 5 6 7
Q
5
EXAMPLE 2: Average Total Cost

Q TC ATC AFC AVC Average total cost

(ATC) equals total
0 $100 n/a n/a n/a
cost divided by the
1 170 $170 $100 $70 quantity of output:
2 220 110 50 60 ATC = TC/Q
3 260 86.67 33.33 53.33
Also,
4 310 77.50 25 52.50
ATC = AFC + AVC
5 380 76 20 56.00
6 480 80 16.67 63.33
7 620 88.57 14.29 74.29

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EXAMPLE 2: Average Total Cost

Q TC ATC $200
Usually,
$175 as in this example,
0 $100 n/a
the ATC curve is U-shaped.
$150
1 170 $170
$125

Costs
2 220 110
$100
3 260 86.67
$75
4 310 77.50 $50
5 380 76 $25
6 480 80 $0
0 1 2 3 4 5 6 7
7 620 88.57
Q
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EXAMPLE 2: The Various Cost Curves Together

$200
$175
$150
ATC
$125

Costs
AVC
$100
AFC
MC $75
$50
$25
$0
0 1 2 3 4 5 6 7
Q
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ACTIVE LEARNING 3
Calculating costs
Fill in the blank spaces of this table.
Q VC TC AFC AVC ATC MC
0 $50 n/a n/a n/a
$10
1 10 $10 $60.00
2 30 80
30
3 16.67 20 36.67
4 100 150 12.50 37.50
5 150 30
60
6 210 260 8.33 35 43.33
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ACTIVE LEARNING 3
Answers
First, AFC
AVC = FC/Q
Use relationship
ATC
deduceTC/Q
FC between
VC/Q= $50 andMC
useand
FCTC
+ VC = TC.

Q VC TC AFC AVC ATC MC

0 $0 $50 n/a n/a n/a
$10
1 10 60 $50.00 $10 $60.00
20
2 30 80 25.00 15 40.00
30
3 60 110 16.67 20 36.67
40
4 100 150 12.50 25 37.50
50
5 150 200 10.00 30 40.00
60
6 210 260 8.33 35 43.33
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EXAMPLE 2: Why ATC Is Usually U-Shaped

As Q rises: $200

Initially, $175
falling AFC $150
pulls ATC down. $125

Costs
Eventually, $100
rising AVC $75
pulls ATC up. $50
Efficient scale: $25
The quantity that $0
minimizes ATC. 0 1 2 3 4 5 6 7
Q
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 EXAMPLE 2: ATC and MC
When MC < ATC, $200 ATC
ATC is falling. MC
$175
When MC > ATC, $150
ATC is rising. $125

Costs
The MC curve $100

crosses the $75

ATC curve at $50
the ATC curve’s $25
minimum.
$0
0 1 2 3 4 5 6 7
Q
12
 Costs in the Short Run & Long Run
 Short run:
Some inputs are fixed (e.g., factories, land).
The costs of these inputs are FC.
 Long run:
All inputs are variable
(e.g., firms can build more factories,
or sell existing ones).
 In the long run, ATC at any Q is cost per unit
using the most efficient mix of inputs for that Q
(e.g., the factory size with the lowest ATC).

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 The Revenue of a Competitive Firm
 Total revenue (TR) TR = P x Q

TR
 Average revenue (AR) AR =
Q
=P

 Marginal revenue (MR): ∆TR

The change in TR from MR =
∆Q
selling one more unit.

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ACTIVE LEARNING 1
Calculating TR, AR, MR
Fill in the empty spaces of the table.

Q P TR AR MR

0 $10 n/a

1 $10 $10

2 $10

3 $10

4 $10 $40
$10
5 $10 $50
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ACTIVE LEARNING 1
Answers
Fill in the empty spaces of the table.
TR ∆TR
Q P TR = P x Q AR = MR =
Q ∆Q
0 $10 $0 n/a
$10
1 $10 $10 $10
Notice that $10
2 $10
Notice
$20
that$10
MR
MR == PP $10
3 $10 $30 $10
$10
4 $10 $40 $10
$10
5 $10 $50 $10
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