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10.11 Types of costs
When we looked at the periods of production of a firm, we said that in the short run the firm can change not all the factors of production used, while in the long run all factors are variable.
It is precisely these differences in the possibility of changing the volume of resources when changing production volumes that forced economists to divide all types of costs into two categories:
- fixed costs;
- variable costs.
Fixed costs(FC, fixed cost) are those costs that cannot be changed in the short term, 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 maintaining equipment, payments to repay previously received loans, as well as all kinds of administrative and other overhead costs. Let's say it is impossible to build a new oil refining plant within a month. Therefore, if next month an oil company plans to produce 5% more gasoline, then this is only possible on existing production facilities and with existing equipment. In this case, a 5% increase in output will not lead to an increase in equipment maintenance and maintenance costs. production premises. These costs will remain constant. Only the amounts paid will change wages, as well as costs for materials and electricity (variable costs).
The fixed cost graph is a horizontal 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, and wages.
Variable costs show the following dynamics depending on 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 costs (AVC, average variable cost) are variable costs per unit of output.
The standard Average Variable Cost graph looks like a parabola.
The sum of fixed costs and variable costs is total costs (TC, total cost)
TC = VC + FC
Average total costs (AC, average cost) are the total costs per unit of production.
Also, average total costs are equal to the sum of average fixed and average variable costs.
AC = AFC + AVC
AC graph looks like a parabola
A special place in economic analysis occupy marginal cost. Marginal cost is important because economic decisions typically involve marginal analysis of available alternatives.
Marginal cost (MC, marginal cost) is the increment in total costs when producing an additional unit of output.
Since fixed costs do not affect the increment in total costs, marginal costs are also an increment in variable costs when producing an additional unit of output.
As we have already said, formulas with derivatives in economic problems are used when smooth functions are given, from which it is possible to calculate derivatives. When we are given individual points (discrete case), then we should use formulas with increment ratios.
The marginal cost graph is also a parabola.
Let's draw a graph of marginal costs together with graphs of average variables and average total costs:
The above graph shows that AC always exceeds AVC since AC = AVC + AFC, but the distance between them decreases as Q increases (since AFC is a monotonically decreasing function).
The graph also shows that the MC graph intersects the AVC and AC graphs at their minimum points. To justify why this is so, it is enough to recall the relationship between average and maximum values already familiar to us (from the “Products” section): when the maximum value is below the average, then the average value decreases with increasing volume. When the marginal value is higher than the average value, the average value increases with increasing volume. Thus, when the marginal value crosses the average value from bottom to top, the average value reaches a minimum.
Now let’s try to correlate the graphs of general, average, and maximum values:
These graphs show the following patterns.
There are 3 types of costs: are common, average And marginal cost that must be compared with similar types of income to determine the firm's profit or loss. Let's consider changes in costs depending on changes in production volumes in the short term.
General costs is the total cost for each given volume of production. In the short term, a distinction is made between total fixed, total variable and gross total as the sum of fixed and variable costs.
1. Total fixed costs (TFC (FC) – total fixed cost). Fixed costs TFC do not change when production volumes change, that is, TFC = const. This includes rent, bank interest, and administrative staff salaries. These costs exist even if the firm produces nothing. For example, the rental fee for a room is $100. per month. This means that regardless of the volume of production, the company must pay this amount rent, including at zero production volume.
The TFC graph looks like a horizontal line, each point on which shows the value of fixed costs for a given volume of production (Fig. 4.1).
TC TFC TC
Rice. 4.1 Changing constants and variables
and total costs in the short term
2. Total variable costs (TVC (VC) – total variable cost)- change with changes in production volumes, namely, they grow with an increase in production - wages, due to an increase in the number of workers, costs of raw materials, materials, etc. Variable costs V.C. change according to the law of diminishing marginal returns and its consequence - increasing marginal costs.
Marginal return of MP resource- this is an additional product, or an increase in the total product produced by an additional unit of a variable resource (labor). Marginal cost (marginal cost) MC- These are additional costs associated with the production of an additional unit of output.
Law of Diminishing Marginal Returns explains the dynamics of production volume associated with increasingly intensive use of fixed production capacity. In the short run, provided that at least one resource remains constant, each additional unit of a variable resource (labor) starting at some point , adds an ever smaller amount to the total product, that is MP marginal return decreases(calculate and draw graphs yourself based on tasks 3). General Product TP at the same time, it grows up to a certain moment at an increasing rate, from a certain moment when the law came into force, at a decreasing rate, and when the marginal product becomes a negative value, total product decreases. The law of diminishing marginal returns means that, at some point, each additional unit of a variable resource is less productive than the previous one.
The consequence of this law is increasing marginal costs (marginal costs) MC, that is, the cost of a variable resource for each additional unit of product increases. Based tasks 3 calculate how marginal costs change M.C. for the production of additional units of production, if the wage rate for each additionally hired worker is equal to 10 dollars, dividing for this additional costs by the amount of additional product created by one additional unit of resource (labor), that is h/pl/ MP. Increasing marginal costs means that rates of growth variable costs, starting from a certain point, increase.
At zero output, variable costs are zero. Q = 0 ® TVC = 0, and then grow, at first at a decreasing rate, when law has not yet entered into force, but from a certain point at an increasing pace, when law begins to act (Fig. 4.1).
3. Total total costs (TC - total cost) is the sum of fixed and variable costs for a given volume of production: TC = TFC +TVC. At zero production volume Q = 0 ® TC = TFC, since variable costs TVC = 0.
Further, as production increases, total costs increase in the same way as variable costs, since fixed costs do not affect changes in costs. The nature of their growth is determined by the law of diminishing marginal returns and the law of increasing marginal costs, that is, they grow first at a decreasing and then at an increasing rate. The total cost schedule TC looks like a shift in the variable cost schedule TVC upward by the amount of TFC. The value of TFC (=const) for any production volume is the distance between the points on the TC and TVC graph.
It is important for a company to know the amount of total costs in order to compare it with total revenue. This will allow the firm to determine its overall profit (or loss). Profit (loss) = TR – TC.
Average costs is the cost per unit of output for a given volume of production. There are average fixed costs, average variable costs, and average total costs.
1. Average fixed costs (AFC – average fixed cost)- These are fixed costs per unit of production. They are determined by dividing fixed costs by the number of products produced: AFC = ® 0.
Since TFC = const, then with an increase in production volume, average fixed costs decrease and tend to zero. This means that with small production volumes the cost of production is high due to high level average fixed costs, and then decreases due to a decrease in AFC (Fig. 4.2).
The AFC graph looks like a hyperbola. The product of AFC values by the corresponding production volume gives a constant value for any production volume, i.e. AFC*Q = TFC= const.
Rice. 4.2. Average and marginal costs
2. Average variable costs (AVC - average variable cost)- These are variable costs per unit of production. Calculated as dividing variable costs by the volume of production: AVC=.
The change in AVC is determined by the law of diminishing marginal returns. When production volume is low, the production process will be relatively inefficient because variable resources will be underutilized and available equipment will be underutilized. Accordingly, variable costs per unit of AVC production will be high. However, as production expands and the variable resource increases, the efficiency of equipment use increases, the marginal return on each additional unit of the variable resource increases, resulting in variable costs per unit of output AVC will decline. Due to the use of more and more variable resources with a constant amount of equipment, at some point the return on each additional unit of variable resource decreases. Consequently, variable costs per unit of output will increase. Schedule AVC initially looks like a descending line, reaches a minimum at a certain volume of production and then represents an ascending line (Figure 4.2).
3. Average total cost (ATC (AC) - average total cost) is the total cost per unit of output. Defined as dividing total costs by the volume of products produced: AC =. Just like average variable costs, average total costs first decrease, reach a minimum, and then increase due to the decreasing and increasing growth rates of total costs TC.
Average total costs can be defined as the sum of average variable and average fixed costs: AC = AVC + AFC. Therefore, the change in AC with an increase in production is influenced by two factors - the change in average variable costs AVC and average fixed costs AFC (Fig. 4.2).
In the first section, average total cost AC decreases as both average variable cost (AVC) and average fixed cost (AFC) decrease. But after a certain point, AC increases as variable costs (AVC) increase. The reduction in AFC in this area will be insignificant, since they have already reached low level, and will have almost no effect on the value of average total costs, so average costs AC will change almost only under the influence of an increase in average variable costs AVC. Since AFC tends to zero, at large production volumes AC approaches AVC (Fig. 4.2).
Graphically, for any production volume, the AC value is the height from the horizontal axis to the point on the AC graph, consisting of two segments AVC and AFC. In this case, AFC represents the distance between the AC and AVC schedules, which decreases with increasing production volume due to a decrease in AFC.
Minimum AC value achieved at more production volume, than the AVC minimum. This is explained by the fact that when AVC begins to increase, AC decreases for some time due to a more significant decrease in AFC. Further, a significant decrease in AFC does not occur, since they tend to zero, so AC begins to grow almost only under the influence of increasing average variable costs AVC.
The firm calculates average costs to compare them with average revenue (that is, the price R), this is how it determines profit or loss per unit of output P - AC. By multiplying the result by the number of products, the company determines the total profit or loss.
Marginal cost (MC – marginal cost)- This additional costs related to production additional unit products. Marginal cost - M.C. show for how long total or variable costs increase due to the production of an additional unit of output, that is, what is the growth rate costs
M.C. are defined as increase in total costs TC per one additional unit products: MC = = .
Since fixed costs do not change, the increase in total costs depends only on the increase in variable costs. Therefore MC can also be defined as increase in variable costs VC per one additional unit of production. The increase in total (or variable) costs is defined as the difference between the subsequent cost value and the previous one.
The marginal cost schedule MC is a reflection and consequence of law of diminishing marginal returns. That is, until the law comes into force, the marginal costs of MS decrease. This means that total TC costs (or TVC variable costs) are increasing at a decreasing rate. When the law comes into force, the marginal cost MC increases, that is, the total costs TC and TVC begin to increase at an increasing rate (Fig. 4.1, 4.2).
Relationship between marginal and average costs. There is a certain mathematical relationship between marginal and average costs. When production increases in the area where marginal costs are less than average costs, average costs decrease, and when marginal costs exceed average costs, average costs begin to rise. Therefore, the marginal cost graph intersects the graph average total and average variable costs at their points minimums(Fig. 4.2). It follows that at the minimum points, average variable and average total costs coincide with the marginal costs MC = AVC min, MS = AC min.
Complete task 2. Using the table and graph, consider how all types of costs change in the short term.
The value of marginal costs MC. Each additional unit adds some amount to revenue and some amount to costs. Therefore, the firm, in order to determine whether to produce the next unit of output or reduce production by this unit, compares the additional (marginal) costs MC and the additional (marginal) revenue MR. If an additional unit of output adds more to revenue than it adds to cost, then marginal revenue is greater than marginal cost MR > MC- the firm produces this additional unit because the firm's profits will increase. If marginal revenue MR is less than marginal cost MC, that is M.R.< МС - the firm refuses to produce an additional unit, since the firm's profit will decrease.
2.3.1. Production costs in a market economy.
Production costs – This is the monetary cost of purchasing the factors of production used. Most cost effective method production is considered to be one in which production costs are minimized. Production costs are measured in value terms based on the costs incurred.
Production costs – costs that are directly associated with the production of goods.
Distribution costs – costs associated with the sale of manufactured products.
The economic essence of costs is based on the problem of limited resources and alternative use, i.e. the use of resources in this production excludes the possibility of using it for another purpose.
The task of economists is to choose the most optimal option for using factors of production and minimizing costs.
Internal (implicit) costs – These are monetary incomes that the company donates, independently using its resources, i.e. These are the income that could be received by the company for independently used resources under the best of conditions. possible ways their applications. Opportunity Cost lost opportunity - the amount of money that is needed to divert a specific resource from the production of good B and use it to produce good A.
Thus, the costs in cash that the company incurred in favor of suppliers (labor, services, fuel, raw materials) are called external (explicit) costs.
Dividing costs into explicit and implicit are two approaches to understanding the nature of costs.
1. Accounting approach: Production costs should include all real, actual expenses in cash (salaries, rent, alternative costs, raw materials, fuel, depreciation, social contributions).
2. Economic approach: production costs should include not only actual costs in cash, but also unpaid costs; associated with missed opportunities for the most optimal use of these resources.
Short term(SR) is the period of time during which some factors of production are constant and others are variable.
Constant factors are the overall size of buildings, structures, the number of machines and equipment, the number of firms that operate in the industry. Therefore the opportunity free access firms in the industry in the short term are limited. Variables – raw materials, number of workers.
Long term(LR) – the period of time during which all factors of production are variable. Those. During this period, you can change the size of buildings, equipment, and the number of companies. During this period, the company can change all production parameters.
Classification of costs
Fixed costs (F.C.) – costs, the value of which in the short term does not change with an increase or decrease in production volume, i.e. they do not depend on the volume of products produced.
Example: building rent, equipment maintenance, administration salary.
C is the amount of costs.
The fixed cost graph is a straight line parallel to the OX axis.
Average fixed costs (A F C) – fixed costs that fall on a unit of output and are determined by the formula: A.F.C. = F.C./ Q
As Q increases, they decrease. This is called overhead allocation. They serve as an incentive for the company to increase production.
The graph of average fixed costs is a curve that has a decreasing character, because As production volume increases, total revenue increases, then average fixed costs represent an increasingly smaller value per unit of product.
Variable costs (V.C.) – costs, the value of which changes depending on the increase or decrease in production volume, i.e. they depend on the volume of products produced.
Example: costs of raw materials, electricity, auxiliary materials, wages (workers). The main share of costs is associated with the use of capital.
The graph is a curve proportional to the volume of output and increasing in nature. But her character can change. In the initial period, variable costs grow at a higher rate than manufactured products. As the optimal production size (Q 1) is achieved, relative savings in VC occur.
Average variable costs (AVC) – the volume of variable costs that falls on a unit of output. They are determined by the following formula: by dividing VC by the volume of output: AVC = VC/Q. First the curve falls, then it is horizontal and increases sharply.
A graph is a curve that does not start at the origin. The general nature of the curve is increasing. The technologically optimal output size is achieved when AVCs become minimal (i.e. Q – 1).
Total costs (TC or C) – the totality of a firm's fixed and variable costs associated with producing products in the short term. They are determined by the formula: TC = FC + VC
Another formula (function of the volume of production output): TC = f (Q).
Depreciation and amortization
Wear- This is the gradual loss of capital resources of their value.
Physical deterioration– loss of the consumer qualities of the means of labor, i.e. technical and production properties.
A decrease in the value of capital goods may not be associated with their loss of consumer qualities; then they speak of obsolescence. It is due to an increase in the efficiency of production of capital goods, i.e. the emergence of similar, but cheaper new means of labor that perform similar functions, but are more advanced.
Obsolescence is a consequence of scientific and technological progress, but for the company this results in increased costs. Obsolescence refers to changes in fixed costs. Physical wear and tear is a variable cost. Capital goods last more than one year. Their cost is transferred to finished products gradually as it wears out - this is called depreciation. Part of the revenue for depreciation is formed in the depreciation fund.
Depreciation deductions:
Reflect an assessment of the amount of depreciation of capital resources, i.e. are one of the cost items;
Serves as a source of reproduction of capital goods.
The state legislates depreciation rates, i.e. the percentage of the value of capital goods by which they are considered to be worn out during the year. It shows how many years the cost of fixed assets must be reimbursed.
Average Total Cost (ATC) – the sum of the total costs per unit of production output:
ATS = TC/Q = (FC + VC)/Q = (FC/Q) + (VC/Q)
The curve is V-shaped. The production volume corresponding to the minimum average total cost is called the point of technological optimism.
Marginal Cost (MC) – an increase in total costs caused by an increase in production by the next unit of output.
Determined by the following formula: MS = ∆TC/ ∆Q.
It can be seen that fixed costs do not affect the value of MS. And MC depends on the increment of VC associated with an increase or decrease in production volume (Q).
Marginal cost shows how much it would cost the firm to increase output per unit. They decisively influence the firm’s choice of production volume, because This is exactly the indicator that the company can influence.
The graph is similar to AVC. The MC curve intersects the ATC curve at the point corresponding to the minimum value of total costs.
In the short run, the company's costs are fixed and variable. This follows from the fact that the company's production capacity remains unchanged and the dynamics of indicators is determined by the increase in equipment utilization.
Based on this graph, you can build a new graph. Which allows you to visualize the company’s capabilities, maximize profits and view the boundaries of the company’s existence in general.
For making a firm's decision, the most important characteristic is the average value; average fixed costs fall as production volume increases.
Therefore, the dependence of variable costs on the production growth function is considered.
At stage I, average variable costs decrease and then begin to grow under the influence of economies of scale. During this period, it is necessary to determine the break-even point of production (TB).
TB is the level of physical sales volume over an estimated period of time at which revenue from product sales coincides with production costs.
Point A – TB, at which revenue (TR) = TC
Restrictions that must be observed when calculating TB
1. The volume of production is equal to the volume of sales.
2. Fixed costs are the same for any volume of production.
3. Variable costs change in proportion to the volume of production.
4. The price does not change during the period for which the TB is determined.
5. The price of a unit of production and the cost of a unit of resources remain constant.
Law of Diminishing Marginal Returns is not absolute, but relative in nature and it operates only in the short term, when at least one of the factors of production remains unchanged.
Law: with the growth of someone’s use of a factor of production, with the rest remaining unchanged, sooner or later a point is reached, starting from which additional use variable factors leads to a decrease in production growth.
The operation of this law presupposes the unchanged state of technical and technological production. And therefore, technological progress can change the scope of this law.
The long-run period is characterized by the fact that the firm is able to change all the factors of production used. During this period variable nature of all used production factors allows the company to use the most optimal combinations of them. This will affect the magnitude and dynamics of average costs (costs per unit of production). If a company decides to increase production volume, but at the initial stage (ATC) will first decrease, and then, when more and more new capacities are involved in production, they will begin to increase.
The graph of long-term total costs shows seven different options (1 – 7) for the behavior of ATS in short-term periods, because The long-term period is the sum of the short-term periods.
The long-run cost curve consists of options called stages of growth. In each stage (I – III) the company operates in the short term. The dynamics of the long-run cost curve can be explained using economies of scale. The company changes the parameters of its activities, i.e. the transition from one type of enterprise size to another is called change in scale of production.
I – in this time interval, long-term costs decrease with an increase in the volume of output, i.e. there are economies of scale – positive effect scale (from 0 to Q 1).
II – (this is from Q 1 to Q 2), at this time interval of production, the long-term ATS does not react to an increase in production volume, i.e. remains unchanged. And the company will have permanent effect from changes in the scale of production (constant returns to scale).
III – long-term ATC increases with an increase in output and there is damage from an increase in the scale of production or diseconomies of scale(from Q 2 to Q 3).
3. IN general view profit is defined as the difference between total revenue and total costs for a certain period of time:
SP = TR –TS
TR ( total revenue) - the amount of cash received by a company from the sale of a certain amount of goods:
TR = P* Q
AR(average revenue) is the amount of cash receipts per unit of products sold.
Average revenue is equal to the market price:
AR = TR/ Q = PQ/ Q = P
M.R. (marginal revenue) is an increase in revenue that arises from the sale of another unit of production. Under perfect competition, it is equal to the market price:
M.R. = ∆ TR/∆ Q = ∆(PQ) /∆ Q =∆ P
In connection with the classification of costs into external (explicit) and internal (implicit), different concepts of profit are assumed.
Explicit costs (external) are determined by the amount of expenses of the enterprise to pay for purchased factors of production from outside.
Implicit costs (internal) determined by the cost of resources owned by a given enterprise.
If we subtract external costs from total revenue, we get accounting profit - takes into account external costs, but does not take into account internal ones.
If internal costs are subtracted from accounting profit, we get economic profit.
Unlike accounting profit, economic profit takes into account both external and internal costs.
Normal profit appears when the total revenue of an enterprise or firm is equal to total costs, calculated as alternative costs. The minimum level of profitability is when it is profitable for an entrepreneur to run a business. “0” - zero economic profit.
Economic profit(clean) – its presence means that resources are used more efficiently at a given enterprise.
Accounting profit exceeds the economic value by the amount of implicit costs. Economic profit serves as a criterion for the success of an enterprise.
Its presence or absence is an incentive to attract additional resources or transfer them to other areas of use.
The company's goals are to maximize profit, which is the difference between total revenue and total costs. Since both costs and income are a function of production volume, the main problem for the company becomes determining the optimal (best) production volume. A firm will maximize profit at the level of output at which the difference between total revenue and total cost is greatest, or at the level at which marginal revenue equals marginal cost. If the firm's losses are less than its fixed costs, then the firm should continue to operate (in the short term); if the losses are greater than its fixed costs, then the firm should stop production.
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Production costs have their own classification, divided in relation to how they “behave” when production volumes change. Costs related to different types behave differently.
Fixed costs (FC, TFC)
Fixed costs, as the name suggests, is a set of enterprise costs that arise regardless of the volume of products produced. Even when the company does not produce (sell or provide services) anything at all. The abbreviation is sometimes used to denote such costs in the literature TFC (time-fixed costs). Sometimes it is used simply - FC (fixed costs).
Examples of such costs could be the monthly salary of an accountant, rent for premises, payment for land, etc.
It should be understood that fixed costs (TFC) are actually semi-fixed. To a certain extent, they are still affected by production volumes. Let's imagine that in the workshop of a machine-building enterprise a system for automatic removal of chips and waste is installed. With an increase in the volume of output, it seems that no additional costs arise. But if a certain limit is exceeded, additional equipment maintenance will be required, replacement of individual parts, cleaning, and elimination of current malfunctions that will occur more often.
Thus, in theory, fixed costs (expenses) in fact are only conditionally so. That is, the horizontal line of costs (costs) in the book is not such in practice. Let's say that it is close to some constant level.
Accordingly, in the diagram (see below), such costs are conventionally shown as a horizontal TFC graph
Variable Costs (TVC)
Variable production costs, as the name suggests, is a set of enterprise costs that directly depend on the volume of products produced. In literature this type costs are sometimes abbreviated TVC (time-variable costs). As the name suggests, " variables" - means increasing or decreasing simultaneously with changes in the volume of products produced by production.
Direct costs include, for example, raw materials and materials that are part of the final product or are consumed during the production process in direct proportion to its load. If an enterprise produces, for example, cast billets, then the consumption of the metal from which these blanks are composed will directly depend on the production program. To denote the expenditure of resources that are directly used to produce a product, the term “direct costs (costs)” is also used. These costs are also variable costs, but not all, since this concept is broader. A significant part of production costs is not directly included in the product, but varies in direct proportion to the volume of production. Such costs are, for example, energy costs.
It is necessary to take into account that a number of costs for resources that the enterprise uses must be separated for the purpose of classifying costs. For example, the electricity that is used in the heating furnaces of a metallurgical enterprise is classified as variable costs (TVC), but the other part of the electricity consumed by the same enterprise for lighting the plant territory is classified as constant costs (TFC). That is, the same resource that the enterprise consumed can be divided into parts that can be classified differently - as variable or as fixed costs.
There are also a number of costs, the costs of which are classified as conditionally variable. That is, they are associated with production processes, but are not directly proportional to production volumes.
In the diagram (below), the variable costs of production are shown as a TVC graph.
This graph differs from the linear one that it should be in theory. The fact is that with sufficiently small production volumes, direct production costs are higher than they should be. For example, a casting mold is designed for 4 castings, but you are producing two. The melting furnace is loaded below its design capacity. As a result, more resources are consumed than the technological standard. After exceeding a certain value of production volumes, the graph of variable costs (TVC) becomes close to linear, but then, when a certain value is exceeded, costs (in terms of unit of output) begin to rise again. This is explained by the fact that when exceeding normal level production capabilities of the enterprise, more resources must be spent on the production of each additional unit of product. For example, pay employees overtime, spend more money on equipment repairs (under irrational operating conditions, repair costs grow geometrically), etc.
Thus, variable costs are considered to obey a linear schedule only conditionally, at a certain interval, within the normal production capacity of the enterprise.
Total enterprise costs (TC)
The total costs of an enterprise are the sum of variable and fixed costs. In the literature they are often referred to as TC (total costs).
That is
TC = TFC + TVC
Where costs by type:
TC - general
TFC - constant
TVC - variables
In the diagram, total costs are reflected by the TC schedule.
Average fixed costs (AFC)
Average fixed costs is called the quotient of dividing the sum of fixed costs by a unit of output. In the literature this quantity is denoted as A.F.C. (average fixed costs).
That is
AFC = TFC / Q
Where
TFC - fixed production costs (see above)
The meaning of this indicator is that it shows how many fixed costs are incurred per unit of production. Accordingly, as production volume increases, each unit of product accounts for an ever smaller share of fixed costs (AFC). Accordingly, a decrease in the amount of fixed costs per unit of product (service) of an enterprise leads to an increase in profit.
On the chart, the value of the AFC indicator is displayed by the corresponding AFC graph
Average Variable Cost (AVC)
Average variable costs called the quotient of dividing the sum of costs for the production of products (services) by their quantity (volume). They are often referred to by the abbreviation AVC(average variable costs).
AVC = TVC/Q
Where
TVC - variable production costs (see above)
Q - quantity (volume) of production
It would seem that, per unit of production, variable costs should always be the same. However, for reasons discussed earlier (see TVC), production costs fluctuate on a per-unit basis. Therefore, for approximate economic calculations, the value of average variable costs (AVC) is taken into account at volumes close to the normal capacity of the enterprise.
On the diagram, the dynamics of the AVC indicator is displayed by a graph with the same name
Average Cost (ATC)
The average cost of an enterprise is the quotient of dividing the sum of all costs of the enterprise by the amount of products produced (work, services). This quantity is often denoted as ATC (average total costs). The term “full unit cost” is also used.
ATC = TC/Q
Where
TC - total (total) costs (see above)
Q - quantity (volume) of production
It should be noted that given value suitable only for very rough calculations, calculations with minor deviations in production values or with an insignificant share of fixed costs in the total costs of the enterprise.
With an increase in production volumes, the estimated value of costs (TC), obtained based on the values of the ATC indicator and multiplied by the production volume, other than the calculated one, will be greater than the actual value (costs will be overestimated), and if they decrease, on the contrary, they will be underestimated. This will occur due to the influence of semi-fixed costs (TFC). Since TC = TFC + TVC, then
ATC = TC/Q
ATC = (TFC + TVC) / Q
Thus, when production volumes change, the value of fixed costs (TFC) will not change, which will lead to the error described above.
Dependence of types of costs on production level
The graphs show the dynamics of values various types costs depending on production volumes at the enterprise.
Marginal Cost (MC)
Marginal cost is the amount of additional costs required to produce each additional unit of output.
MC = (TC 2 - TC 1) / (Q 2 - Q 1)
The term "marginal cost" (in the literature is often referred to as MC - marginal costs) is not always correctly perceived, since it was the result of a not entirely correct translation English word margin. In Russian, “ultimate” often means “striving for the maximum,” whereas in this context it should be understood as “being within the boundaries.” Therefore, authors who know English language(let’s smile here), instead of the word “marginal” they use the term “marginal costs” or even just “marginal costs”.
From the above formula it is easy to see that MC for each additional unit of production will be equal to AVC on the interval [Q 1; Q 2].
Since TC = TFC + TVC, then
MC = (TC 2 - TC 1) / (Q 2 - Q 1)
MC = (TFC + TVC 2 - TFC - TVC 1) / (Q 2 - Q 1)
MC = (TVC 2 - TVC 1) / (Q 2 - Q 1)
That is, marginal (marginal) costs are exactly equal to the variable costs necessary to produce additional products.
If we need to calculate MC for a specific production volume, then we assume that the interval we are dealing with is equal to [ 0; Q ] (that is, from zero to the current volume), then at the “point zero” variable costs are equal to zero, production is also equal to zero and the formula simplifies to the following form:
MC = (TVC 2 - TVC 1) / (Q 2 - Q 1)
MC = TVC Q/Q
Where
TVC Q is the variable costs required to produce Q units of output.
Note. You can evaluate the dynamics of various types of costs using technical
Production costs in the short term are divided into constant and variable.
Fixed costs (TFC) are costs of production that are independent of the firm's output and must be paid even if the firm produces nothing. Associated with the very existence of the company and depend on the amount of constant resources and the corresponding prices of these resources. These include: salaries of senior executives, interest on loans, depreciation, rental space, cost of equity capital and insurance payments.
Variable costs (TVC) are those costs, the value of which varies depending on the volume of output; this is the sum of the company's expenses on variable resources used in the production process: wages of production personnel, materials, payments for electricity and fuel, transportation costs. Variable costs increase as production volume increases.
Total (total) costs (TC) – represent the sum of fixed and variable costs: TC=TFC+TVC. At zero output, variable costs are equal to zero, and total costs are equal to fixed costs. After the start of production, variable costs begin to increase in the short term, causing an increase in total costs.
The nature of the total (TC) and total variable cost (TVC) curves is explained by the principles of increasing and diminishing returns. As returns increase, the TVC and TC curves grow to a decreasing degree, and as returns begin to fall, costs increase to an increasing degree. Therefore, to compare and determine production efficiency, average production costs are calculated.
Knowing the average production costs, it is possible to determine the profitability of producing a given quantity of products.
Average production costs are the costs per unit of output produced. Average costs, in turn, are divided into average fixed, average variable and average total.
Average Fixed Cost (AFC) – represents the fixed cost per unit of output. AFC=TFC/Q, where Q is the quantity of products produced. Since fixed costs do not vary with output, average fixed costs fall as the quantity sold increases. Therefore, the AFC curve continuously decreases as production increases, but does not cross the output axis.
Average variable costs (AVC) – represent variable costs per unit of production: AVC=TVC/Q. Average variable costs are subject to the principles of increasing and decreasing returns to factors of production. The AVC curve has an arcuate shape. Under the influence of the principle of increasing returns, average variable costs initially fall, but, having reached a certain point, begin to increase under the influence of the principle of diminishing returns.
There is an inverse relationship between variable production costs and the average product of a variable factor of production. If the variable resource is labor (L), then average variable costs are wages per unit of output: AVC=w*L/Q (where w is the wage rate). Average product labor APL = output volume per unit of factor Q/L used: APL=Q/L. Result: AVC=w*(1/APL).
Average total cost (ATC) is the cost per unit of output produced. They can be calculated in two ways: by dividing total costs by the number of products produced, or by adding average fixed and average variable costs. The AC (ATC) curve has an arcuate shape like average variable costs, but exceeds it by the amount of average fixed costs. As production volume increases, the distance between AC and AVC decreases, due to more rapid decline AFC but never reaches the AVC curve. The AC curve continues to fall after a release in which AVC is minimal because AFC's continued decline more than offsets weak AVC growth. However, with further production growth, the increase in AVC begins to exceed the decrease in AFC, and the AC curve turns upward. The minimum point of the AC curve determines the most efficient and productive level of production in the short term.
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