Examples of typical variable costs include fuel, raw materials, and some labour costs. Consider the following hypothetical example of a boat building firm.
Total variable costs TVC will increase as output increases. Given that total fixed costs TFC are constant as output increases, the curve is a horizontal line on the cost graph. The total variable cost TVC curve slopes up at an accelerating rate, reflecting the law of diminishing marginal returns. The total cost TC curve is found by adding total fixed and total variable costs.
Its position reflects the amount of fixed costs, and its gradient reflects variable costs. Average fixed costs are found by dividing total fixed costs by output. As fixed cost is divided by an increasing output, average fixed costs will continue to fall.
The average variable cost AVC curve will at first slope down from left to right, then reach a minimum point, and rise again. Average total cost ATC is also called average cost or unit cost. These costs are measured in dollars. In contrast, marginal cost, average cost, and average variable cost are costs per unit.
In the previous example, they are measured as cost per haircut. It would be as if the vertical axis measured two different things. In addition, as a practical matter, if they were on the same graph, the lines for marginal cost, average cost, and average variable cost would appear almost flat against the horizontal axis, compared to the values for total cost, fixed cost, and variable cost.
If you graphed both total and average cost on the same axes, the average cost would hardly show. Improve this page Learn More. Skip to main content.
Module 7: Production and Costs. Search for:. Average Costs and Curves Learning Objectives Describe and calculate average total costs and average variable costs Calculate and graph marginal cost Analyze the relationship between marginal and average costs.
Watch It Watch this clip as a continuation from the video on the previous page to see how average variable cost, average fixed costs, and average total costs are calculated. Try It. Watch It Watch this video to learn how to draw the various cost curves, including total, fixed and variable costs, marginal cost, average total, average variable, and average fixed costs.
Where do marginal and average costs meet? Why are total cost and average cost not on the same graph? Glossary average total cost: for any quantity of output, total cost divided by the quantity of output average variable cost: for any quantity of output, variable cost divided by the quantity of output. Agrarian is often used as a modifier for other terms, such as agrarian society an economy that relies heavily on agricultural production , agrarian society a society based on the institutions that emerge from a heavy reliance on agricultural production , or agrarian movement a political movement designed to product agricultural production.
Because farming was one of the first and remains one of the most fundamental activities undertaken by even the most primitive society, agrarian is typically associated with less developed, as in the phrase a "less developed, agrarian nation. When compared with price per unit revenue , average variable cost AVC indicates whether or not a profit-maximizing firm should shut down production in the short run. Average variable cost is one of three average cost concepts important to short-run production analysis.
The other two are average total cost and average fixed cost. A related concept is marginal cost. Average variable cost is the total variable cost per unit of output incurred when a firm engages in short-run production. For example, as the number of barbers rises from two to three, the marginal output gain is only 20; and as the number rises from three to four, the marginal gain is only To understand the reason behind this pattern, consider that a one-man barber shop is a very busy operation.
The single barber needs to do everything: say hello to people entering, answer the phone, cut hair, sweep up, and run the cash register. A second barber reduces the level of disruption from jumping back and forth between these tasks, and allows a greater division of labor and specialization. The result can be greater increasing marginal returns. However, as other barbers are added, the advantage of each additional barber is less, since the specialization of labor can only go so far.
The addition of a sixth or seventh or eighth barber just to greet people at the door will have less impact than the second one did. This is the pattern of diminishing marginal returns. As a result, the total costs of production will begin to rise more rapidly as output increases. In this case, the addition of still more barbers would actually cause output to decrease, as shown in the last row of Table 2.
This pattern of diminishing marginal returns is common in production. The plot of land is the fixed factor of production, while the water that can be added to the land is the key variable cost. As the farmer adds water to the land, output increases. But adding more and more water brings smaller and smaller increases in output, until at some point the water floods the field and actually reduces output.
Diminishing marginal returns occur because, at a given level of fixed costs, each additional input contributes less and less to overall production. The breakdown of total costs into fixed and variable costs can provide a basis for other insights as well. The first five columns of Table 3 duplicate the previous table, but the last three columns show average total costs, average variable costs, and marginal costs.
These new measures analyze costs on a per-unit rather than a total basis and are reflected in the curves shown in Figure 2. Average total cost sometimes referred to simply as average cost is total cost divided by the quantity of output.
Average cost curves are typically U-shaped, as Figure 2 shows. Average total cost starts off relatively high, because at low levels of output total costs are dominated by the fixed cost; mathematically, the denominator is so small that average total cost is large. Average total cost then declines, as the fixed costs are spread over an increasing quantity of output.
In the average cost calculation, the rise in the numerator of total costs is relatively small compared to the rise in the denominator of quantity produced. But as output expands still further, the average cost begins to rise. At the right side of the average cost curve, total costs begin rising more rapidly as diminishing returns kick in. Average variable cost obtained when variable cost is divided by quantity of output. Note that at any level of output, the average variable cost curve will always lie below the curve for average total cost, as shown in Figure 2.
The reason is that average total cost includes average variable cost and average fixed cost. However, as output grows, fixed costs become relatively less important since they do not rise with output , so average variable cost sneaks closer to average cost. Average total and variable costs measure the average costs of producing some quantity of output.
Marginal cost is somewhat different. Marginal cost is the additional cost of producing one more unit of output. So it is not the cost per unit of all units being produced, but only the next one or next few.
Marginal cost can be calculated by taking the change in total cost and dividing it by the change in quantity. For example, as quantity produced increases from 40 to 60 haircuts, total costs rise by — , or The marginal cost curve is generally upward-sloping, because diminishing marginal returns implies that additional units are more costly to produce.
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