welcome back to the foundation course in managerial economics in this module we are going to talk
about cost curves we are going to look at how the variable cost uh looks like with increasing
units of uh output how uh fixed costs look like we are going to introduce various concepts
of cost so let me proceed . so there are different types of costs now
one is called the fixed cost which is where fixed costs do not vary with quantity of output
produced and we have variable costs where variable costs vary with the quantity of output
produced so probably you are being able to already relate to the example of the tailoring
shop that i took in the previous module and there we said that there is a input of a room
uh or the shop area of 200 square feet where basically the tailoring activity is happening
and there are 2 sewing machines which are again fixed
so even if the shop is not producing any garment then also the shopkeeper or the owner of the
shop has to incur the costs of the room and the cost of the sewing machine and so these
are the cost of the room and the sewing machine is basically the fixed cost that we are defining
here and variable cost is basically if he wants to increase the number of garments that
he wants to produce from his shop he has to keep on increasing the number of people he
hires to produce the garment so however there is a diminishing marginal
uh product of labour that we saw in the previous uh module that he cannot keep on increasing
his output forever by keeping on increasing the number of units of labour say there is
only a limit till which he gets some positive output of the out of the out of hiring more
and more units of labour so anyway so these are the the the cost that
he incurs by hiring the labour is called the variable cost because this cost depends on
the number of units of output he would like to produce so total cost for a producer is
equal to fixed cost plus variable cost . so next we are going to discuss about cost
curves but before we talk about cost curves uh let me show with an example what we mean
by the variable cost the fixed cost etc so lets continue with the example that we took
earlier . so now he is trying to produce some output
but first he incurs the fixed cost he is incurring a fixed cost of the land and the sewing machines
so say he is incurring rupees 1000 here and for the 2 machines he is incurring a amount
of rupees 1000 so basically his fixed cost is so let me write it as so basically his
fixed cost or fc is 2000 and even when his output is 0 so even when his output is 0 he
is having to incur this fixed cost of 2000 now he starts hiring labour and labour is
his variable cost his variable cost is labour and here if he has no person to work for him
so his output is 0 as soon as he hires one labour his variable cost is not 1 but 100
rupees because one person gets a salary of 100 rupees so this is variable cost is 100
and his fixed cost is 2000 and the output he produces is 1 garment then his variable
cost is 200 as soon as he hires 2 people his fixed cost is still same
he now is able to produce sorry he is able to produce 3 garments so similarly so this
is how his cost structure looks like 500 and these are the fixed cost stays same and 6
8 9 9 and probably he is not going to hire this additional person because he is still
able to produce 9 garments without hiring him so we will talk about his decision till
here so lets not talk about this portion because
any producer rational producer is not going to incur extra cost without increasing his
amount of output so the this is his so what is his total cost then so to produce every
unit of output so this is his total cost is now fixed cost plus variable cost for 0 units
it is 2000 for for 3 units its 2200 for 6 units 2300 2400 2500 so this is his cost schedule
this is his total cost schedule and these are his and these are his output. so he knows
its like this now
lets try to draw the cost curve lets try to draw the cost curve because uh you already
have seen the demand supply framework where we have a price on the vertical axis output
in the horizontal axis and there was a demand curve the supply curve and similarly we would
like to uh bring our cost curve or production decision everything in that framework of price
and quantity and try to be able to see if we can figure out what is the amount of output
optimum output the producer is producing what is the cost he is incurring what is the profit
level that he is expecting what is the profit that he is making etc so lets try to draw
the cost curve now before i draw the cost curve let me start
with the production function see the production function basically gives me the okay before
i talk about the cost curve one more thing is this is the variable cost and this is the
fixed cost and when i say fixed cost it is as if right now the producer is not being
able to change this like he is not at any point of time he is not adding any additional
sewing machine or he is not renting another shop or renting some more amount of space
to add to his existing shop so this is the reason that it is fixed cost
it is fixed so he is not increasing the increasing or decreasing the uh capital that he already
owns all that he is changing is the variable cost so basically all his decisions are about
the variable cost this decision he has already taken so all his decisions are around the
variable cost that is how many people to hire now so his so secondly his cost is about since
this cost has already been taken into account like there is he knows that no matter how
many units of output i produce this is going to stay the same so his decision is about
the cost incurred in hiring the labour the variable cost so lets start from the production
function that we drew in the earlier module .
so this is his production function and this was his labour this was his output that he
produced and the production function looked something like this the production function
looked like this so this was the production function and where his capital was fixed and
we were basically changing the units of labour so this is for the fixed fixed area of the
land where he is operating and the fixed 2 inputs of machine sewing machines that he
has and he is basically just changing the units of labour here so this is his production
function now cost is about how much money he has to
spend so lets convert this lets look at instead of hiring every unit of labour uh so labour
is basically every person that additional person he hires or additional number of hours
that he makes them work so if instead of writing labour here in physical units lets write it
in terms of the wage that he is paying to the labour
so if i convert it into rupees say first unit of labour he hires he is having to pay a wage
of amount of money of 100 rupees for 2 people he pays 200 3 people 300 4 people 400 6 people
600 so this is in this is the cost that he is having to incur to produce every unit of
output here this is the cost that he is having to incur to produce uh or this is the variable
cost so this is the variable cost now as you remember from our demand supply
analysis that i said that my price is always going to be on the y axis and my output is
going to be the on the x axis so i think it will be useful for us if we are able to look
at cost also in this framework of having the price that i am having to pay on the vertical
axis and the output getting produced on the x axis. so how can i get that from here so
if i am looking at the cost curve how can i do that from this so this is my production
function what i basically do is what i basically do is uh let me draw on this side .
now i am trying to change the axis of this graph or this diagram here so i would like
to have the price or cost figures on the x axis and sorry i would like to have the output
in the x axis instead of y axis and i would like to have the price or cost figures on
the y axis to do that all that i have to do is flip this graph
so basically i flip the curve so that i have the flipped curve in this space and what i
now have is a curve which looks something like this curve which looks like this so when
i flip the curve i have the output on the what output that i have on the uh y axis output
i have on the y axis and i have the inputs in cost terms on the y axis output i have
on the x axis and i have the inputs in cost term on the y axis
so that basically gives me the cost curve so is this what cost curve is this this is
basically the variable cost curve so this is my variable cost curve because it shows
me gives me the variable cost that is 100 200 300 400 500 so my variable cost is on
the vertical axis my output is on the x axis and this gives me my variable cost curve because
this curve shows how much variable cost i have to incur to produce every extra unit
of output now if this is my variable cost how should
i draw my what does my fixed cost look like now fixed cost is say fixed cost is say uh
its 2000 here lets lets bring it down to uh so that its i am just making it 200 so that
i can draw within this space so say my fixed cost is 200 so my fixed cost looks like this
this is my fixed cost and so my total cost is basically this is my total cost so this
is my total cost so this is 200 plus so this is my total cost curve and this is my variable
cost curve .
now having drawn the cost curves a few more variations of the cost or different uh that
concepts of the cost that we need to understand are the average variable cost that is variable
cost produced per unit of output the average fixed cost that is average uh average fixed
cost that is fixed cost per unit of output average total cost which is total cost divided
by output and marginal cost ill come to marginal cost later .
let me first show you what my lets first define the average costs so first
average fixed cost so as you can see very well from here average fixed cost what would
it look like average fixed cost what would it look like
now average fixed cost would be in the first uh average fixed cost would be here it is
not applicable only 0 units are produced in the next it is 200 200 then it is 100 2 units
produced then it is 66 it is 200 3 yes it is sorry uh 200 3 okay i am sorry 200 then
200 divided by 3 it is 66.3 sorry 63 then 300 q fixed cost is 200 33.3 and 200 then
it is 25 so average fixed cost is basically it keeps
on decreasing so what should it look like so average fixed cost would look like this
so this is my cost again so average fixed cost and output average fixed cost basically
keeps on decreasing so this is my average fixed cost next i am going to calculate my
average variable cost . now average variable cost is variable cost
divided by output and that is uh variable cost it is 100 then 200 by 3 then 300 by 3
30 400 by sorry 300 by 6 and 400 divided by 8 then 500 divided by 9 so average variable
cost what we see is average variable cost initially it declines and then it starts increasing
again so that means my average variable cost is a u shaped curve while my
average fixed cost keeps on decreasing so this is my average variable cost
so this is how my average variable cost and average fixed cost look like and next we are
going to discuss about marginal cost now as we said people think at rational people think
at margin so we have already discussed about marginal product and we are going to see what
happens to marginal cost so basically the producer is trying to figure out what is the
marginal cost he is incurring by hiring an extra unit of labour
so marginal cost is basically uh marginal cost is not going to be influenced by the
fixed cost it is going to be influenced only by variable cost so basically what we are
looking at is lets look at the total cost and total output here .
so marginal cost is equal to del total cost divided by del output so additional output
to be produced how much additional cost we incur that is what we are trying to figure
out here so from 0 to 1 unit what is the del q that is there now del q is del q is 1 here
here del q is 2 here del q is 3 here del q is 2
here del q is 1 and here del cost del cost is equal to 10 here it is again 10 here 10
here so it is my additional cost is 10 for every unit so this is my uh oh sorry sorry
sorry i have done a major mistake i i deleted the zeros at the end its actually 200 now
200 plus this is a gross mistake that i have done here
this is fixed cost plus the fixed cost i removed one zero from here so fixed cost plus variable
cost is here 300 it is 400 here it is 500 here it is 600 here and it is 700 here so
uh apologies for the mistake uh this is my total cost here and additional cost that i
am incurring for producing every unit is here del cost is basically 100 so del cost that
i am incurring for producing the changes in output at every level the del cost is 100
and this is my here it is uh 1 this is 2 this is 3 this is 2 and this is 1
so my marginal cost will be equal to marginal cost is equal to 100 divided by 1 100 second
it is 100 divided by 2 50 then it is 100 divided
by 3 lets put 33.3 then it is again 100 divided by 2 is equal to 50 and 100 divided by 1 is
equal to 100 so this is how my marginal cost curve looks like and let me now draw the marginal
cost curve . so let me draw the marginal cost curve so
my marginal cost curve now looks like so it initially decreases my marginal cost initially
decreases and then it moves up again so my marginal cost initially falls and then it
moves up again and marginal cost is minimum at 33.3 marginal cost is minimum at 33.3 and
another thing if you may note from i have removed the average variable cost you may
remember that in the variable average variable cost the average variable cost kept on decreasing
till it reached a level of 50 and then it started increasing again
so average variable and when average variable cost was falling so uh let me uh write the
average variable cost also here so this is my marginal cost and
this is my average variable cost
so my average variable cost looked like 100 then 66.3 63.3 i think 66.3 and then 50 then
50 then 55.5 so i think my average variable cost looked like this and if i draw the average
variable cost with the marginal cost i am going to see that initially my average variable
cost is more than my marginal cost till it reaches a level of 50 and after that my average
variable cost so this is my then my average variable cost is actually less than my marginal
cost so my average variable cost is less than my
marginal cost and this is the level 50 where my marginal cost intersects with my variable
cost and after that my variable cost is actually less than my marginal cost now why does that
happen so basically marginal cost when marginal cost is declining variable cost is marginal
cost is less than the average variable cost and when marginal cost is increasing it is
more than the average variable cost and the average variable cost and marginal cost they
intersect at the point where average variable cost is minimum they intersect at the point
where average variable cost is minimum so uh what is the intuition behind it. so
the intuition behind it is very simple that say for example we are imagining a a cgp of
a person so the grade point average of a person and say he has got the grades of all the subjects
except economics and the average that he has got of all from all the subjects is say uh
5.0 so now if the grade that he receives from economics is the additional uh the the additional
amount that will be added to the average so that you can imagine as the marginal cost
and that marginal amount when it is added it will reduce the average if it is less than
the average that is if the grade that he receives from economics is less than 5 that will bring
down his average and if the grade that he receives is more than 5 that will raise his
average so obviously it intersects the marginal cost
intersects the average variable cost at its minimum and uh that is the reason behind it
and so that basically uh so so this is how basically how our cost curves look like so
this is my marginal cost this is my average variable cost and another reason for the variable
cost and the total variable cost is also looks like this
now the total variable cost also is u shaped because the average variable cost is initially
decreasing and then it is increasing but average fixed cost basically brings down the total
cost so that is the reason that the average total cost is also u shaped and that brings
us to the end of the discussion about cost curve
so we have basically introduced the cost curves and in the next uh module we are going to
see how the cost curves look in the short run and the long run we are going to introduce
the concept of long run and short run and how the producer basically makes his choices
uh in the short run and in the long run thank you