Y2 2) Fixed and Variable Costs (AFC, TFC, AVC)

Summary

This script discusses short-run costs in business, emphasizing that they occur when at least one production factor is fixed. It differentiates between explicit costs, which require payment, and implicit costs, which represent opportunity costs. The script explains fixed costs, which remain constant regardless of output, and variable costs, which change with output. It also covers average fixed cost, which decreases as output increases, and the average variable cost curve, shaped by the law of diminishing returns. The example of hiring workers to produce units illustrates how increasing returns can reduce average variable costs, but diminishing returns can cause them to rise.

Takeaways

• 🕒 The short-run in business is defined by the presence of at least one fixed factor of production, not by a specific time frame.
• 🏭 In the short-run, businesses typically have two fixed factors of production: land and capital.
• 🔄 The long-run is characterized by all factors of production being variable.
• 💰 Explicit costs are actual payments made by a business, while implicit costs represent the opportunity cost, which is the profit forgone from the next best alternative.
• 💼 Fixed costs are those that do not change with the level of output, such as rent and salaries.
• 📈 Variable costs increase as output increases, including wages, utility bills, raw material costs, and transport costs.
• 📊 Total Fixed Costs (TFC) remain constant and do not vary with output, represented by a horizontal line in cost curves.
• 📉 Average Fixed Cost (AFC) decreases as output increases because it is the TFC divided by an increasing quantity, resulting in a downward-sloping curve.
• 😃 The shapes of TFC and AFC curves are not influenced by the law of diminishing returns, making them straightforward to understand.
• 📈 Average Variable Cost (AVC) is influenced by the law of diminishing returns, initially falling as labor productivity increases and then rising as diminishing returns set in.
• 📘 The shape of the AVC curve resembles a smile, due to the initial increase in labor productivity followed by a decrease as more workers are hired and the law of diminishing returns takes effect.

Q & A

What is the definition of the short-run in business?

The short-run is a period of time in business where there is at least one fixed factor of production. It is not defined by a specific time frame but by the variability of factors of production.

What are the two fixed factors of production in the short-run?

In the short-run, the two fixed factors of production are typically land and capital.

How are costs categorized in economics?

In economics, costs are categorized into explicit costs, which require actual payment, and implicit costs, which are the opportunity costs and do not require physical payment.

What are fixed costs?

Fixed costs are costs that do not vary with output. They must be paid regardless of the level of production, such as rent, salaries, interest on loans, advertising, and business rates.

What are variable costs?

Variable costs are costs that change with the level of output. They increase as more is produced, such as wages, utility bills, raw material costs, and transport costs.

How does the total fixed cost (TFC) curve look graphically?

The total fixed cost curve is a horizontal line, indicating that it remains constant regardless of the level of output.

What is the formula for calculating average fixed cost (AFC)?

The formula for calculating average fixed cost is Total Fixed Cost (TFC) divided by quantity (Q), which results in a downward sloping curve as output increases.

Why does the average variable cost (AVC) curve have a 'smiley face' shape?

The average variable cost curve has a 'smiley face' shape due to the law of diminishing returns. Initially, as more workers are hired, productivity increases, reducing average variable costs. However, as diminishing returns set in, productivity falls, causing average variable costs to rise.

How does the law of diminishing returns affect average variable cost?

The law of diminishing returns causes average variable cost to initially decrease as productivity increases with additional workers, but then to increase as productivity begins to fall once too many workers are hired.

What is the relationship between marginal product and average variable cost?

An increasing marginal product leads to a decrease in average variable cost, while a decreasing marginal product (as a result of diminishing returns) leads to an increase in average variable cost.

What is the next topic to be covered after discussing fixed and variable costs?

The next topic to be covered is marginal cost and average cost, which will be discussed in a subsequent video.