Total Cost TC Total Cost of Production

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• Total Cost (TC) Total Cost of Production
• Total Variable Cost (TVC) The Total Costs of
  Labor, Raw Materials, and other Inputs to
  Production
• Total Fixed Cost (TFC) Costs that must be paid
  regardless of the amount produced

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• Total Cost Total Variable Cost Total Fixed
  Cost
• We usually write TC TVC TFC
• If there is no production, then TVC 0 and TC
  TFC
• If we know TC and Total Revenue, we know whether
  were making a profit, but not if profits are
  maximized

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• Average Total Cost (ATC) Total Cost divided by
  Quantity Produced
• ATC is how much it costs, on average, to produce
  each unit of output
• Average Variable Cost (AVC) Total Variable Cost
  divided by Quantity Produced
• AVC is the cost of variable inputs, on average,
  to produce each unit of output
• For example, AVC is the amount you pay a worker
  per unit output

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• Average Fixed Cost (AFC) Total Fixed Cost
  divided by Quantity Produced
• AFC is the cost of fixed inputs, on average, to
  produce each unit of output
• For example, AFC is the rent paid per unit of
  output

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• Average Total Cost Average Variable Cost
  Average Fixed Cost
• This comes from TC/QTVC/Q TFC/Q
• If we know ATC and the price, we know whether
  producing and selling one more unit will increase
  profits
• We dont know, however, whether profits are
  maximized

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• Average Variable Cost is U-Shaped because of
  diminishing marginal product
• Initially, doubling the number of workers more
  than doubles output, so AVC is dropping
• Eventually, doubling the number of workers
  increases output by less than 100, so AVC rises

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• Average Fixed Cost is strictly decreasing
• We divide a fixed number of dollars by a larger
  and larger quantity
• Average Total Cost is also U-shaped
• Get ATC by adding up AVC and AFC vertically
• That is, stack the graphs on top of each other

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• Short-Run Shut Down Point
• If the price is below the minimum of AVC (i.e.,
  the bottom of the U-shaped curve), then youre
  paying your workers and suppliers more, per unit,
  than youre getting from selling that unit!
• The minimum AVC is the short run shut down point
• Its short run because, even though youre losing
  money, youre losing less than if you stopped
  producing entirely!

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• Long-Run Shut Down Point
• You can lose money for awhile, but eventually
  have to make a profit
• If the price is below the minimum of the ATC
  curve then youre losing money in the long run
  and should shut down
• The cost per unit output of materials and labor,
  plus the cost of rent, etc. exceeds the amount
  youre selling the good for

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• Profit Maximization
• If the cost of producing one more unit output is
  smaller than the amount you can sell that unit
  for, youll make more profit by producing that
  unit
• If the cost of producing one more unit output is
  greater than the amount you can sell that unit
  for, youll decrease your profit by producing
  that unit

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• The cost of producing one more unit of output is
  the Marginal Cost (MC)
• Marginal Cost equals the Change in Total Cost
  divided by the Change in Output
• That is, (?TC / ?Q) MC
• Therefore, if P gt MC then you should increase
  production
• If P lt MC then you should decrease production

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• Profit is Maximized where P MC
• At this point the additional cost of production
  exactly equals the amount you can sell the good
  for

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• The Marginal Cost curve looks sort of like a
  check mark
• Because of diminishing returns to production, MC
  initially decreases, then increases
• If MC is below AVC then AVC is decreasing
• If MC is above AVC then AVC is increasing
• The MC curve crosses the AVC curve at the bottom
  (minimum) of the AVC curve

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• Similarly, if the MC lt ATC then ATC is decreasing
• If MC gt ATC then ATC is increasing
• The MC curve crosses the ATC curve at the bottom
  of the ATC curve

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• Where MC crosses the AVC is the Short-Run Shut
  Down Point
• Where MC crosses the ATC is the Long-Run Shut
  Down Point

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An Example

• Healthy Harrys Juice Bar has the following Cost
  Schedules

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• Harrys Total Fixed Cost is 30
• For example, for Q 2 TC 55 and TVC 25
• Therefore, TFC for Q 2 is TC TVC, or 55 -
  25, which is 30
• You can check that TFC is the same for every
  quantity

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Average Costs

• For Q 1, TVC 10 and TC 40
• Average Variable Cost for Q 1 equals TVC / Q,
  or 10/1 10
• Average Total Cost for Q 1 equals TC / Q, or
  40/1 40
• Average Fixed Cost for Q 1 equals TFC / Q, or
  30/1 30
• Note that ATC AFC AVC

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• What is ATC for Q 2?
• What is AVC for Q 2?
• What is AFC for Q 2?

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• The Marginal Cost of the First Vat equals ((TC
  when Q 1) (TC when Q 0)) divided by (Q1
  minus Q0)
• That is, (40 - 30) / (1 0) 10
• The Marginal Cost of the Second Vat equals (55 -
  40) / (2 1) 15

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