Y2 2) Fixed and Variable Costs (AFC, TFC, AVC)
Summary
TLDRThis 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.
Outlines
💼 Understanding Short-Run Costs
The paragraph discusses the concept of short-run costs in business, emphasizing that the short-run is defined by the presence of at least one fixed factor of production, typically land and capital. It differentiates between explicit costs, which require payment, and implicit costs, which are the opportunity costs represented by the next best alternative forgone. The paragraph further explains fixed costs, which remain constant regardless of output, and variable costs, which increase with production. Examples of fixed costs include rent, salaries, interest on loans, advertising, and business rates. Variable costs encompass wages, utility bills, raw material costs, and transport costs. The speaker also introduces the idea of mapping cost curves in the short-run, focusing on total fixed costs (TFC) and average fixed costs (AFC), which are not influenced by the law of diminishing returns and hence are straightforward to understand and graph.
📈 The Shape of Cost Curves
This section delves into the graphical representation of cost curves in the short-run, particularly focusing on total fixed costs (TFC) and average fixed costs (AFC), which are constant and decline as output increases, respectively. The speaker then transitions to discuss the average variable cost (AVC) curve, which is influenced by the law of diminishing returns. An example is used to illustrate how AVC changes with different numbers of workers: initially decreasing due to increasing marginal returns, then increasing as diminishing returns set in. The speaker uses a numerical example with wages as the only variable cost to demonstrate how AVC falls and then rises, reflecting changes in labor productivity and marginal product. The paragraph concludes with a practical demonstration of how these concepts fit into a diagram, showing the relationship between output levels, average variable costs, and the impact of the law of diminishing returns.
Mindmap
Keywords
💡Short-run
💡Fixed Costs
💡Variable Costs
💡Explicit Costs
💡Implicit Costs
💡Total Fixed Costs (TFC)
💡Average Fixed Cost (AFC)
💡Law of Diminishing Returns
💡Average Variable Cost (AVC)
💡Marginal Product
💡Total Variable Cost (TVC)
Highlights
The short-run is defined by the presence of at least one fixed factor of production.
In the short-run, land and capital are typically fixed factors of production.
Costs are divided into explicit costs (requiring payment) and implicit costs (opportunity costs).
Fixed costs are independent of the level of output produced.
Variable costs increase as more output is produced.
Examples of fixed costs include rent, salaries, interest on loans, advertising, and business rates.
Variable costs include wages, utility bills, raw material costs, and transport costs.
Total fixed costs (TFC) remain constant regardless of output.
Average fixed cost (AFC) decreases as output increases due to dividing a constant by an increasing number.
The shapes of TFC and AFC curves are not influenced by the law of diminishing returns.
Average variable cost (AVC) is influenced by the law of diminishing returns, resulting in a U-shaped curve.
An increase in labor productivity can reduce average variable costs.
Diminishing returns set in when additional workers lead to a decrease in marginal product and an increase in AVC.
The AVC curve's shape is explained by the law of diminishing returns and changes in labor productivity.
The video will cover marginal cost and average cost in upcoming episodes.
Transcripts
hi everybody short-run costs we'll
remember what the short-run is for a
business it is a period of time when
there is at least one fixed factor of
production we don't define it in terms
of six months or one year we don't
define it in terms of actual time we
define it in terms of the variability of
our factors of production so when there
is at least one fixed factor production
and business is in the short-run usually
there are two fixed factors of
production in the short-run land and
capital whereas in the long-run all
factors of production are variable
that's a crucial start but also costs
are quite unique in economics there are
two different groups of costs we have
our explicit costs costs that require
actual payment and we have our implicit
costs implicit costs for a business is
just their opportunity cost and that's
always the profit they could have made
doing their next best alternative that
is a cost
it doesn't require physical payment
therefore its implicit but it is a cost
and then we have our two explicit costs
of fixed costs and our variable costs
fixed costs are costs that do not vary
with output so even if nothing is being
produced a business has to pay fixed
costs where is variable costs are costs
that do vary with output you pay more of
these as you produce more so let's take
some examples of fixed cost cost you
have to pay regardless of how much
output you're producing things like rent
salaries salaries are contractual right
so you have to pay those regardless of
how much you're producing usually a
yearly contract there so salaries are
fixed interest on loans advertising
business rates this is taxes and having
a physical premises as a business here
business rates these are all cost you
have to pay regardless of how much apple
you're producing where it's variable
costs if you look at these you have to
pay more of these the more you're
producing wages are more flexible than
salaries are wages can change more
quickly so wages are a variable cost
utility bills so your gas electricity
bills your water bills internet bills
they're all a variable your raw material
cost your transport costs all will
increase the more that you produce so
these are variable whereas these are
some good examples of fixed costs what
we want to do now is to map what our
cost codes look like in the short-run
and in this video we're going to look at
a fixed cost average fixed cost an
average variable cost total fix costs an
average fixed cost are very very easy to
draw because their shapes have got
nothing to do with the law of
diminishing returns it's the only two
cost curves in the short-run that have
got nothing to do with the law of
diminishing returns so they are very
easy to draw let's start by looking at
total fixed costs Weaver said that fixed
costs are costs that do not vary with
output so total fixed costs is just
going to be constant it's gonna be on a
constant figure over a given range of
output so total fixed cost is just gonna
look like that really simple I've put
some equations at the top of how you can
work out total fixed cost average fixed
cost well let me take this equation to
use and calculate average fixed cost TFC
over q when we know that TFC is a fixed
number it's a constant number and if Q
is rising output is increasing
increasing you're dividing a constant
number by an ever-increasing number and
that means your average fixed cost is
gonna fall for for the more that we
produce or average fixed cost is gonna
look something like that downward
sloping looking like that using this
equation that makes a lot of sense so
these two cares are very simple to
remember make sure we learn the
equations as well they are shaped not
because of the law of diminishing
returns at all so therefore very simple
to get your head around the average
variable cost curve though is shade due
to the law of diminishing returns we're
going to look at that now the average
variable cost curve looks like this
looks like a nice smiley face to
calculate it we get a total variable
cost divided by quantity or we can do
average cost minus average fixed cost
but why does it look like this smiley
face well due to the law of diminishing
marginal returns let's understand how by
using a very simple numerical example
let's assume that there is a business
and for this business operating in the
short-run wages are the only variable
cost and we'll also assume that workers
are paid a daily wage rate of a hundred
pounds let's say one worker is hired
that means total variable cost is a
hundred pounds and let's say that worker
produces ten units well average variable
cost is therefore a hundred divided by
ten that's going to be ten pounds let's
now say to work is a hide total variable
cost is 200 pounds together they produce
30 units 200 divided by 30
is 6 pounds 67 to 2 DP let's now say 3
workers are hired total variable cost is
gonna be 300 pounds they together
produce 70 units and therefore ABC is
300 divided by 70 that's going to give
us 4 pounds and 28 to 2 DB so what we
can see here is up to 3 workers can we
see that there are increasing returns to
labor labor productivity is rising
marginal product is rising and that is
reducing average variable cost marginal
product is 10 here then 20 and then 40
increasing marginal product increasing
labor productivity will reduce average
variable cost but look the law of
diminishing returns diminishing returns
kicks in when we hire this fourth worker
so four workers are hired total variable
cost is now 400 pounds and these workers
together produce 80 units that means
that average variable cost is 400 about
880 that's 5 pounds let's keep going 5
workers are hired TVCs 500 and they
produce 85 units 500 divided by 85 is 5
pounds and 88 to 2 decimal places
let's go all the way down to 10 workers
are hired that means total variable cost
of a thousand pounds they produce 100
units let's say that's average variable
cost of 10 pounds so we can see that
when we hire this fourth worker
diminishing returns kick in marginal
product is falling from 40 there to 10
to 5 right it's decreasing when labor
productivity is falling and marginal
product is falling average variable
costs will be rising okay so we can see
that average variable cost will fall but
when the law of diminishing returns
kicks in it will start to rise and that
explains the shape here how we can put
these numbers to our diagram you don't
need to do this or make things
unnecessarily messy but let's do it
together so for the first 10 units for
the first 10 years let's say we're over
here so that's 10 units there we have a
VC of 10 pounds but then we have 30
units coming next so let's say 30 units
gives us an average variable cost of
6.67 so that fits nicely there and then
to get the 70 units we hit on minimum so
70 is there and we get to 4 pounds
28 so we can see higher labor
productivity we see a higher marginal
product and a reduction in average
variable cost then diminishing returns
kicks in so to get to 80
it's here to get to 80 let's say it's
over here somewhere we get to an average
variable cost of five to get to 85 which
is only just over there let's say 85 we
get to five pounds 88 etc and then when
we get to 100 when we get to 100 which
is over here we get back to our average
variable cost of ten so the numbers very
much fit the diagram lovely so that
explains the shape of the AVC curve very
much due to the law of diminishing
returns whereas our fixed cost curves
TFC and AFC had nothing to do with the
law of diminishing returns in fact they
are the only two curves that we learn
only two short-run Costco's they've got
nothing to do a law of diminishing
returns all the others are because of
this law so three curves there we are
not going to touch total variable cost I
do that in a video later in this
playlist check that out if you want but
we now need to continue look at marginal
cost and average cost that's coming next
make sure you stay tuned for that very
important video I'll see you then
[Music]
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