measuring the costs of production
Costs are defined as those expenses faced by a business in the process of supplying goods and services to consumers. In the short run (where there are fixed and variable factors of production) we make a distinction between fixed and variable costs. Examples of each are given below.
SHORT RUN COSTS OF PRODUCTION
(TC) = TOTAL FIXED COST (TFC) + TOTAL VARIABLE COSTS (TVC)
Fixed costs relate to the fixed factors of production and do not vary directly with the level of output. (I.e. they are exogenous of the level of production in the short run).
Good examples to use are rent of buildings, leasing of capital equipment, the annual uniform business rate charged by local authorities, the costs of full-time contracted salaried staff, interest rates on loans, the depreciation of fixed capital (due to age) and the costs of business insurance.
Total fixed costs (TFC) remain constant as output increases. Average fixed cost (AFC) = Total Fixed Costs (TFC) / Output (Q) Average fixed costs will fall continuously with output because the total fixed costs are being spread over a higher level of production causing the average cost to fall.
Examples of fixed costs
Rent of buildings, leasing of plant and equipment, local business rates, the costs of salaried staff, interest rates on loans, depreciation of capital (due to age) and insurance premiums.
Average fixed cost (AFC) =
Fixed Costs (TFC)
An increase in fixed costs has no effect at all on the variable costs of production. This means that only the average total cost curve shifts. There is no change at all on the marginal cost curve leading to no change in the profit maximising price and output of a business.
Average fixed costs will fall continuously with output because the total fixed costs are being spread over a higher level of production causing the average cost to fall
Average fixed costs falls as output increases. A business can "spread their over head costs" by increasing output in the short run. Average fixed cost will never be zero if there are positive total fixed costs.
These are costs that vary directly with output since more variable units are required to increase output. Examples are the costs of essential raw materials and components, the wages of part-time staff or employees paid by the hour, the costs of electricity and gas and depreciation of capital inputs due to wear and tear. Total variable cost rises as output increases.
Average variable cost (AVC) = Total Variable Costs (TVC) /Output (Q) AVC depends on the cost of employing variable factors compared to the average productivity of these factors (usually labour productivity). If additional units of labour can be hired at a constant cost there will be an inverse relationship between average product and average variable cost. Therefore, when average product is maximised, AVC will be minimised.
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