Output Output Average Fixed cost Average Variable Cost Average Total Cost Margin
ID: 1178096 • Letter: O
Question
Output
Output
Average Fixed cost Average Variable Cost Average Total Cost Marginal Cost Price Total Revenue Marginal Revenue 0 $ 345.00 1 $ 180.00 $ 135.00 $ 315.00 $ 300.00 2 $ 90.00 $ 127.50 $ 217.50 $ 249.00 3 $ 60.00 $ 120.00 $ 180.00 $ 213.00 4 $ 45.00 $ 112.50 $ 157.50 $ 189.00 5 $ 36.00 $ 111.00 $ 147.00 $ 165.00 6 $ 30.00 $ 112.50 $ 142.50 $ 144.00 7 $ 25.71 $ 115.70 $ 141.41 $ 126.00 8 $ 22.50 $ 121.90 $ 144.40 $ 111.00 9 $ 20.00 $ 130.00 $ 150.00 $ 99.00 10 $ 18.00 $ 139.50 $ 157.50 $ 87.00Explanation / Answer
Implicit Cost + Explicit Cost = Total Cost. Implicit cost is not equal to total cost, but a component of it. A simple example:
Paul builds a cabinet. He spends 2 hours building the cabinet. He could have been working instead and normally makes $25/hour at his job. Since he was building a cabinet he wasn't paid for this time. The materials to make the cabinet cost him $20.
His Explicit Costs are: $20 in materials
His Implicit Costs are: $25/hr x 2 hrs= $50 of foregone pay
His Total Costs are: $20 in materials + $50 of foregone pay = $70 Total Costs
Explicit cost are costs that you know such as wages, rent, materials, ect.
Implicit cost are costs that are there but hard to put an actual number on. Example would be a sales person being used for covering an admin job instead of doing their sales job. How much income opportunity did you lose? There is no way to know for certain but it did cost something.
In the short run (which is what this question is about), as output increases, the average total cost decreases where the marginal cost is below it.
First you have to realise that increasing and decreasing output will affect average fixed costs and average variable costs.
Consider the following (explanation to these specific points is at the bottom of the page):
Average fixed costs (AFC) decrease as output increases.
A fall in average fixed costs leads to a fall in marginal costs.
Let's call the decrease in AFC, and therefore a decrease in marginal costs, "X"
Average variable costs (AVC) increase as output increases.
It's the one most associated with marginal cost.
A rise in average variable costs leads to a rise in marginal costs.
Let's call the increase in AVC, and therefore an increase in marginal costs, "Y"
It is possible to deduce that:
When X is greater than Y, the decrease is greater than the increase in marginal costs. Because it's going down more than it's going up, marginal cost is going to get pulled down and fall.
When X is less than Y, the decrease is smaller than the increase in marginal costs. Because it's going up more than it's going down, marginal cost is going to get pulled up and rise.
You've just read about how marginal costs go up and down, according to the average variable & fixed costs. Now to pull in average total costs, as if it wasn't annoying enough.
The average total cost (ATC) of the firm is found by: Average fixed costs + average variable costs
Average total cost essentially changes depending on marginal costs (MC).
If marginal cost is below average total cost, the average is going to get pulled down.
It's important to remember that MC can rise even if it's below the average... but eventually it will rise above it.
If marginal cost is above average total cost, the average is going to get pulled up.
Marginal cost always equals the average total cost when the average is at its lowest.
This is when the two curves cross over each other, and is linked to the law of diminishing marginal returns.
So, the change from a decreasing ATC to an increasing one is caused by a rising MC.
Because AVC is the thing that really pulls MC up significantly, leading to the change, it is the most important factor when considering these types of costs... because AFC eventually flatterns out and doesn't really make a difference as output is increased more and more.
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