Average costs (AC, ATC) are the gross costs per unit of output:

ATC=TC/Q

This type of cost is of particular importance for understanding market equilibrium.

Average cost calculation

Accordingly, the formulas for calculating average fixed and average variable costs are:

Average fixed costs

AFC=FC/Q

Average variable costs

AVC=VC/Q

The relationship of average, average variable and average fixed costs

ATC=AFC+AVC

The average cost curve is usually U-shaped.

As can be seen from the graph, at the initial stage of production, the average costs are very high, due to the fact that large fixed costs fall on a small volume of products. As production increases, fixed costs are incurred by more and more units of production, and average costs fall rapidly, reaching their minimum. Further, as production grows, the value of average costs begins to be influenced not by fixed, but by variable costs. Therefore, due to the law of diminishing returns, the curve begins to go up.

The average cost curve is of great importance to entrepreneurs because allows you to determine at what volume of production the cost per unit of output will be minimal.

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Variable costs (VC) are the costs of the firm, the total value of which for a given period of time is directly dependent on the volume of production and sales of products (for example, the cost of wages, raw materials, fuel, energy, transport services).

The distinction between fixed and variable costs is significant. Fixed costs must be paid even if no product is produced at all. An entrepreneur can control variable costs by changing the volume of production.

Types of variable production costs

Opportunity cost is the term for lost profits when one of the existing alternatives is chosen over another. The amount of lost profits is measured by the utility of the most valuable alternative that was not chosen to replace the other. Thus, opportunity costs are found wherever a rational decision is needed and there is a need to choose between the available options.

Cost-push inflation (Inflationary recession) is inflation that is caused by an upward movement on the graph of the short-term aggregate supply curve, at the same time when the aggregate demand curve remains stationary in its original place or significantly lags behind the movement of the aggregate supply curve on the graph.

The upward movement of the short-term aggregate supply curve is caused by a sharp increase in the prices of production factors as a result of natural disasters, leading to crop losses, the disappearance of conventional sources of oil, coal, etc. In addition, an increase in costs may be associated with a depreciation of the national currency, since in this case the costs for the purchase of the necessary raw materials, machine tools, technologies and simple consumer goods increase sharply, which reduces incomes and leads to a drop in living standards.

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10.11 Types of costs

When we considered the periods of production of a firm, we talked about the fact that in the short run the firm may not change all the factors of production used, while in the long run all factors are variable.

It is these differences in the ability to change the volume of resources with a change in the volume of production that led economists to break down all types of costs into two categories:

1. fixed costs;
2. variable costs.

fixed costs(FC, fixed cost) - these are those costs that cannot be changed in the short run, and therefore they remain the same with small changes in the volume of production of goods or services. Fixed costs include, for example, rent for premises, costs associated with the maintenance of equipment, repayment of previously received loans, as well as various administrative and other overhead costs. For example, it is impossible to build a new oil refinery within a month. Therefore, if an oil company plans to produce 5% more gasoline next month, then this is possible only at existing production facilities and with existing equipment. In this case, a 5% increase in output will not lead to an increase in the cost of equipment maintenance and maintenance of production facilities. These costs will remain constant. Only the amounts of wages paid, as well as the costs of materials and electricity (variable costs) will change.

The fixed cost schedule is a horizontal straight line.

Average fixed costs (AFC, average fixed cost) are fixed costs per unit of output.

variable costs(VC, variable cost) are those costs that can be changed in the short term, and therefore they grow (decrease) with any increase (decrease) in production volumes. This category includes costs for materials, energy, components, wages.

Variable costs show such dynamics from the volume of production: up to a certain point they increase at a killing pace, then they begin to increase at an increasing pace.

The variable cost schedule looks like this:

Average variable cost (AVC) is the variable cost per unit of output.

The standard Average Variable Cost Chart looks like a parabola.

The sum of fixed costs and variable costs is total cost (TC, total cost)

TC=VC+FC

Average total cost (AC, average cost) is the total cost per unit of output.

Also, average total costs are equal to the sum of average fixed and average variables.

AC = AFC + AVC

AC graph looks like a parabola

A special place in economic analysis is occupied by marginal costs. Marginal cost is important because economic decisions usually involve marginal analysis of available alternatives.

Marginal cost (MC) is the incremental cost of producing an additional unit of output.

Since fixed costs do not affect the increment in total costs, marginal cost is also an increment in variable costs when an additional unit of output is produced.

As we have already said, formulas with a derivative in economic problems are used when smooth functions are given, from which it is possible to calculate derivatives. When we are given separate points (discrete case), then we should use formulas with ratios of increments.

The marginal cost graph is also a parabola.

Let's plot the marginal cost graph together with the graphs of average variables and average total costs:

In the above graph, you can see that AC always exceeds AVC because AC = AVC + AFC, but the distance between them gets smaller as Q increases (because AFC is a monotonically decreasing function).

You can also see on the chart that the MC chart crosses the AVC and AC charts at their lows. To substantiate why this is so, it suffices to recall the relationship between average and marginal values ​​already familiar to us (from the “Products” section): when the marginal value is below the average, then the average value decreases with an increase in volume. When the limit value is higher than the average value, the average value increases as the volume increases. Thus, when the limit value crosses the mean value from the bottom up, the mean value reaches a minimum.

Now let's try to correlate the graphs of the general, average, and limit values:

These graphs show the following patterns.

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Classification of the firm's costs in the short run.

When analyzing costs, it is necessary to distinguish between costs for the entire output, i.e. general (full, total) production costs, and unit production costs, i.e. average (specific) costs.

Considering the costs of the entire output, it can be found that when the volume of production changes, the value of some types of costs does not change, while the value of other types of costs is variable.

fixed costs(FC – fixed costs) are costs that do not depend on the volume of output. These include building maintenance costs, capital repairs, administrative and management expenses, rent, property insurance payments, and certain types of taxes.

The concept of fixed costs can be illustrated in Fig. 5.1. Plot on the x-axis the amount of output (Q), and on the y-axis - costs (WITH). Then the fixed cost schedule (FC) will be a straight line parallel to the x-axis. Even when the enterprise does not produce anything, the value of these costs is not equal to zero.

Rice. 5.1. fixed costs

variable costs(VC – variable costs) are the costs, the value of which varies depending on the change in production volumes. Variable costs include the cost of raw materials, materials, electricity, wages of workers, the cost of auxiliary materials.

Variable costs increase or decrease in proportion to output (Fig. 5.2). In the initial stages of

Rice. 5.2. variable costs

production, they grow at a faster rate than manufactured products, but as the optimal output is reached (at the point Q 1) the growth rate of variable costs is decreasing. In larger firms, the unit cost of producing a unit of output is lower due to the increase in production efficiency, provided by a higher level of specialization of workers and more complete use of capital equipment, so the growth of variable costs becomes already slower than the increase in production. In the future, when the enterprise exceeds its optimal size, the law of diminishing productivity (profitability) comes into play and variable costs again begin to overtake production growth.

Law of diminishing marginal productivity (profitability) states that, starting from a certain point in time, each additional unit of a variable factor of production brings a smaller increment in total output than the previous one. This law takes place when any factor of production remains unchanged, for example, production technology or the size of the production area, and is valid only for a short period of time, and not for a long period of human existence.

Let's explain how the law works with an example. Assume that the enterprise has a fixed amount of equipment and workers work in one shift. If the entrepreneur hires additional workers, then work can be carried out in two shifts, which will lead to an increase in productivity and profitability. If the number of workers increases even more, and workers begin to work in three shifts, then productivity and profitability will increase again. But if you continue to hire workers, there will be no increase in productivity. Such a constant factor as equipment has already exhausted its possibilities. The application of additional variable resources (labor) to it will no longer give the same effect, on the contrary, starting from this moment, the costs per unit of output will increase.

The law of diminishing marginal productivity underlies the behavior of a producer who maximizes his profit and determines the nature of the supply function of the price (supply curve).

It is important for the entrepreneur to know to what extent he can increase the volume of production so that the variable costs do not become very large and do not exceed the profit margin. The difference between fixed and variable costs is significant. A manufacturer can control variable costs by changing the volume of output. Fixed costs must be paid regardless of the volume of production and are therefore beyond the control of the administration.

General costs(TS– total costs) is a set of fixed and variable costs of the firm:

TC= FC + VC.

Total costs are obtained by summing the fixed and variable cost curves. They repeat the configuration of the curve VC, but separated from the origin by the value FC(Fig. 5.3).

Rice. 5.3. General costs

For economic analysis, average costs are of particular interest.

Average cost is the cost per unit of output. The role of average costs in economic analysis is determined by the fact that, as a rule, the price of a product (service) is set per unit of output (per piece, kilogram, meter, etc.). Comparison of average costs with the price allows you to determine the amount of profit (or loss) per unit of product and decide on the feasibility of further production. Profit serves as a criterion for choosing the right strategy and tactics of the company.

There are two types of average costs:

Average fixed costs ( AFC - average fixed costs) - fixed costs per unit of production:

AFC= FC / Q.

As the volume of production increases, fixed costs are distributed over an increasing number of products, so that average fixed costs decrease (Fig. 5.4);

Average variable costs ( ABC – average variable costs) - variable costs per unit of output:

AVC= VC/ Q.

As output grows ABC first they fall, due to the increasing marginal productivity (profitability) they reach their minimum, and then, under the influence of the law of diminishing productivity, they begin to grow. So the curve ABC has an arcuate shape (see Fig. 5.4);

average total cost ( ATS – average total costs) - total costs per unit of output:

ATS= TS/ Q.

Average cost can also be obtained by adding average fixed and average variable costs:

ATC= A.F.C.+ AVC.

The dynamics of average total costs reflects the dynamics of average fixed and average variable costs. While both are declining, the average total costs fall, but when, as output increases, the increase in variable costs begins to overtake the fall in fixed costs, the average total costs begin to rise. Graphically, average costs are represented by the summation of the curves of average fixed and average variable costs and have a U-shape (see Fig. 5.4).

Rice. 5.4. Production costs per unit of output:

MS - limit, AFC - average constants, AVC - average variables,

ATS - average total cost of production

The concepts of total and average costs are not enough to analyze the behavior of the firm. Therefore, economists use another type of cost - marginal.

marginal cost(MS – marginal costs) is the cost associated with producing an additional unit of output.

The category of marginal cost is of strategic importance because it allows you to show the costs that a firm will have to incur if it produces one more unit of output or
save in the event of a reduction in production for this unit. In other words, marginal cost is the amount that a firm can directly control.

Marginal cost is obtained as the difference between the total cost of production ( n+ 1) units and production costs n product units:

MS= TSn+1 – TSn or MS= D TS/D Q,

where D is a small change in something,

TS- general costs;

Q- volume of production.

Graphically, marginal costs are shown in Figure 5.4.

Let us comment on the main relationships between average and marginal costs.

1. Marginal cost ( MS) do not depend on fixed costs ( FС), since the latter do not depend on the volume of production, but MS are incremental costs.

2. As long as marginal costs are less than average ( MS< AC), the average cost curve has a negative slope. This means that the production of an additional unit of output reduces the average cost.

3. When marginal costs are equal to average ( MS = AC), which means that average costs have stopped decreasing, but have not yet begun to grow. This is the point of minimum average cost ( AC= min).

4. When marginal costs become greater than average ( MS> AC), the average cost curve goes up, which indicates an increase in average cost as a result of the production of an additional unit of output.

5. Curve MS crosses the average variable cost curve ( AVC) and average costs ( AC) at the points of their minimum values.

To calculate costs and evaluate the production activities of enterprises in the West and in Russia, various methods are used. In our economy, methods based on the category prime cost, including the total cost of production and sale of products. To calculate the cost, the costs are classified into direct, directly going to the creation of a unit of goods, and indirect, necessary for the functioning of the company as a whole.

Based on the previously introduced concepts of costs, or costs, we can introduce the concept added value, which is obtained by subtracting variable costs from the total income or revenue of the enterprise. In other words, it consists of fixed costs and net income. This indicator is important for assessing production efficiency.

In the classification of costs, in addition to fixed, variable and average, there is a category of marginal costs. All of them are interconnected, in order to determine the value of one type, it is necessary to know the indicator of another. So, marginal costs are calculated as a private increase in total costs and an increase in output. To minimize costs, that is, to achieve what each economic entity strives for, it is necessary to compare marginal and average costs. What conditions of these two indicators are optimal for the manufacturer will be discussed in this article.

Types of costs

In the short term, when the impact of economic factors can be realistically foreseen, a distinction is made between fixed and variable costs. They are easy to classify, since the variables change with the volume of output of goods, but the constants do not. Expenses associated with the operation of buildings, equipment; salaries of management personnel; payment of watchmen, cleaners is a monetary cost of resources that make up fixed costs. Whether the enterprise produces products or not, they still have to pay monthly.

The wages of the main workers, raw materials and materials are the resources that make up the variable factors of production. They vary depending on the output.

Total costs are the sum of fixed and variable costs. Average cost is the amount of money spent on the production of one unit of a good.

Marginal cost measures the amount of money that must be spent to increase output by one unit.

marginal cost chart

The graph shows two types of cost curves: marginal and average. The intersection point of the two functions is the minimum average cost. This is no coincidence, since these costs are interconnected. Average cost is the sum of average fixed and variable costs. Fixed costs do not depend on the volume of production, and when considering marginal costs, their change with an increase / decrease in volume is of interest. Therefore, marginal cost implies an increase in variable costs. This implies that the average and marginal costs must be compared with each other when finding the optimal volume.

It can be seen from the graph that marginal costs begin to increase faster than average costs. That is, average costs are still decreasing with volume growth, while marginal costs have already crept up.

Balance point

Turning our attention once again to the graph, we can conclude:

• AC is located above MC, since it is a large value, including, in addition to variables, fixed costs. While MC consists of an increase in only variable costs.
• The previous fact explains the right location of the AS relative to the MS. This is because per unit of volume growth, MC contains the difference in variable costs, and average costs (AC), in addition to variables, also include fixed costs.
• After the intersection of the functions at the minimum point, there is an increase in the costs of the marginal nature faster than the average ones. In this case, production becomes unprofitable.

The equilibrium point of the firm in the market corresponds to the optimal size of production at which the economic entity receives a stable income. The value of this volume is equal to the intersection of the MC curves with AS at the minimum value of AS.

Comparison of AC and MS

When the marginal incremental cost is less than the average cost, it makes sense for the firm's top managers to decide to increase production.

When these two quantities are equal, equilibrium is reached in the volume of output.

It is worth stopping the increase in output when the value of MC is reached, which will be higher than AC.

Average costs in the long run

All costs in the long run have a variable property. The firm, which has reached the level at which average costs begin to rise in the long run, is forced to begin to change the factors of production, which had previously remained unchanged. It turns out that the total average costs are identical to the average variables.

The curve of average costs in the long run is a line contiguous at the minimum points of the curves of variable costs. The graph is shown in the figure. At point Q2, the minimum value of costs is reached, and then it is necessary to observe: if there is a negative effect of scale, which rarely occurs in practice, then it is necessary to stop the increase in output at the volume in Q2.

Marginal income MP

An alternative approach in a modern market economy to determine the volume of production at which costs will be minimal and profit maximum is to compare the values ​​of the marginal values ​​of income and costs.

Marginal revenue is the increase in cash that a company receives from an additional unit of output sold.

Comparing the amounts that each additionally introduced unit of output adds to gross costs and gross income, one can determine the point of profit maximization and cost minimization, expressed by finding the optimal volume.

Analytical comparison of MS and MR

For example, the fictitious data of the analyzed company are presented below.

Table 1

Each unit of volume corresponds to a market price, which decreases as supply increases. The income generated by the sale of each unit of output is determined by the product of the volume of output and the price. Gross costs rise with each additional unit of output. Profit is determined after deducting all costs from gross income. The marginal values ​​of income and costs are calculated as the difference between the corresponding gross values ​​from the increase in production volume.

Comparing the last two columns of the table, it is concluded that in the production of goods from 1 to 6 units, marginal costs are covered by income, and then their growth is traced. Even with the release of goods in the amount of 6 units, maximum profit is achieved. Therefore, after the firm increases the production of goods to 6 units, it will not be profitable for it to increase it further.

Graphical comparison of MS and MR

When graphical determination of the optimal volume, the following conditions are characteristic:

• Marginal revenue over cost - expansion of production.
• The equality of values ​​determines the equilibrium point at which the maximum profit is achieved. The production output becomes stable.
• The marginal cost of production exceeds the marginal revenue in magnitude - a sign of unprofitable output at a loss to the firm.

Marginal cost theory

In order for an economic entity to make a decision to increase the volume of production, such an economic tool as a comparison of marginal costs with average costs and marginal income comes to the rescue.

If, in the usual sense, costs are the costs of output, then the marginal type of these costs is the amount of money that must be invested in production in order to increase output by an additional unit. When output is reduced, marginal cost indicates the amount of money that can be saved.

The purpose of creating a business - opening a company, building a factory with the subsequent release of planned products - is to make a profit. But the increase in personal income requires considerable costs, not only moral, but also financial. All monetary expenditures aimed at the production of a good are called costs in economics. To work without loss, you need to know the optimal volume of goods / services and the amount of funds spent for their release. For this, average and marginal costs are calculated.

Average cost

With an increase in the volume of production, the costs dependent on it grow: raw materials, wages of the main workers, electricity, and others. They are called variables and have different dependencies for different quantities of output of goods/services. At the beginning of production, when the volume of goods produced is small, variable costs are significant. When increasing the number of products, the level of costs decreases, because there is an effect of economies of scale. However, there are costs incurred by the entrepreneur even with zero output of goods. Such costs are called fixed: utilities, rent, salaries of administrative staff.

Total costs are the totality of all costs for a specific amount of goods produced. But to understand the economic costs invested in the process of creating a unit of goods, it is customary to refer to average costs. That is, the quotient of total costs to output is equal to the value of average costs.

marginal cost

Knowing the value of the funds spent on the implementation of one unit of the good, it cannot be argued that an increase in output by another 1 unit will be accompanied by an increase in total costs, in the amount equal to the value of average costs. For example, to produce 6 cupcakes, you need to invest 1200 rubles. It is immediately easy to calculate that the cost of one cupcake should be at least 200 rubles. This value is equal to the average cost. But this does not mean that the preparation of another baking will cost 200 rubles more. Therefore, to determine the optimal volume of production, it is necessary to know how much it will take to invest in order to increase output by one unit of the good.

Economists come to the aid of the firm's marginal cost, which helps to see the increase in total costs associated with the creation of an additional unit of goods / services.

Calculation

MC - such a designation in the economy has marginal costs. They are equal to the private increase in total costs to the increase in volume. Since the increase in total costs in the short run is caused by an increase in average variable costs, the formula can be: MC = ΔTC / Δvolume = Δaverage variable costs / Δvolume.

If the values ​​of gross costs corresponding to each unit of output are known, then marginal costs are calculated as the difference between two neighboring values ​​of total costs.

Relationship between marginal and average costs

Economic business decisions should be made after marginal analysis, which is based on marginal comparisons. That is, the comparison of alternative solutions and the determination of their effectiveness occur by evaluating the cost increment.

Average and marginal costs are interrelated, and a change in one relative to the other is the reason for adjusting output. For example, if marginal spending is less than average, then it makes sense to increase output. It is worth stopping the increase in output when marginal costs are above average.

The equilibrium will be the situation in which the marginal cost is equal to the minimum value of the average cost. That is, it makes no sense to further increase production, since additional costs will grow.

Schedule

The presented graph shows the costs of the company, where ATC, AFC, AVC are the average total, fixed and variable costs, respectively. The marginal cost curve is labeled MC. It has a convex shape to the x-axis and at the minimum points intersects the curves of average variables and total costs.

From the behavior of average fixed costs (AFC) on the graph, we can conclude that increasing the scale of production leads to their decrease, as mentioned earlier, there is an effect of economies of scale. The difference between ATC and AVC reflects the amount of fixed costs, it is constantly decreasing due to the approach of AFC to the x-axis.

Point P, characterizing a certain volume of output of goods, corresponds to the equilibrium state of the enterprise in the market. If you continue to increase the volume, then the costs will need to be covered by profits, as they will begin to increase sharply. Therefore, the firm should stop at the volume at point P.

marginal revenue

One approach to calculating production efficiency is to compare marginal costs with marginal revenue, which is equal to the increase in cash from each additional unit of goods sold. However, the expansion of production is not always associated with an increase in profits, because the dynamics of costs is not proportional to the volume and with an increase in supply, demand decreases and, accordingly, the price.

The firm's marginal cost is equal to the price of the good minus marginal revenue (MR). If marginal cost is below marginal revenue, then production can be expanded, otherwise it must be curtailed. Comparing the values ​​of marginal cost and income, for each value of the volume of output, it is possible to determine the points of minimum cost and maximum profit.

Profit maximization

How to determine the optimal size of production, allowing to maximize profits? This can be done by comparing marginal revenue (MR) and marginal cost (MC).

Each new good produced adds marginal revenue to total revenue, but also increases total cost by marginal cost. Any unit of output whose marginal revenue exceeds its marginal cost should be produced because the firm earns more revenue from the sale of that unit than it adds to costs. Production is profitable as long as MR > MC, but as output increases, increasing marginal cost due to the law of diminishing returns will make production unprofitable, as it will begin to exceed marginal revenue.

Thus, if MR > MC, then production must be expanded if MR< МС, то его надо сокращать, а при MR = МС достигается равновесие фирмы (максимум прибыли).

Features when using the rule of equality of limit values:

• The condition MC = MR can be used to maximize profit in the case when the cost of the good is higher than the minimum value of the average variable costs. If the price is lower, the company does not achieve its goal.
• Under conditions of pure competition, when neither buyers nor sellers can influence the formation of the value of a good, marginal revenue is equivalent to the price of a unit of goods. This implies the equality: P = MC, in which marginal cost and marginal price are the same.

Graphical representation of a firm's equilibrium

Under pure competition, when price equals marginal revenue, the graph looks like this:

Marginal costs, the curve of which crosses the line parallel to the x-axis, characterizing the price of the good and marginal income, form a point showing the optimal sales volume.

In practice, there are moments when doing business when an entrepreneur must think not about maximizing profits, but minimizing losses. This happens when the price of a good decreases. Stopping production is not the best solution, since fixed costs must be paid. If the price is less than the minimum value of the gross average expenditures, but exceeds the value of the average variables, then the decision should be based on the output of goods in the volume obtained by crossing the marginal values ​​(income and costs).

If the price of a product in a purely competitive market falls below the firm's variable costs, then management must take the responsible step of temporarily stopping the sale of the goods until the value of the identical good rises in the next period. This will be the impetus for an increase in demand due to a decrease in supply. An example is agricultural firms that sell products in the autumn-winter period, and not immediately after harvest.

Costs in the long run

The time interval during which changes in the production capacity of the enterprise can occur is called the long-term period. The firm's strategy should include future cost analysis. In the long run, long-run average and marginal costs are also considered.

With the expansion of production capacity, there is a decrease in average costs and an increase in volumes up to a certain point, then the cost per unit of output begins to grow. This phenomenon is called the scale effect.

The long-run marginal spending of an enterprise shows the change in all costs due to an increase in output. Curves of average and marginal costs in time correlate to each other similarly to the short-term period. The main strategy in the long run is the same - this is the definition of production volumes by means of the equality MC = MR.