OK, let's call this chapter 11, part 2, 
and now that we understand a little bit
about production, let's talk about how
that shapes up in terms of costs...  Because
firms in order to maximize profits are
of course looking to minimize costs....And
even in deciding which Q is the
correct quantity to produce costs are
going to hugely influence that.  So we're
going to go through fixed, variable, and total....
put them all into average form,  and then
we will look at MC,  because of course
everything so far has been about MB and
MC.  Okay so let's talk about our costs in
the most basic form and we divide them
up into fixed and variable costs,  and
fixed costs plus variable are going to
equal the total.  So this basic
mathematical relationship is one you
should commit to memory.  Fixed costs are
any cost that do not vary with the level
of output, so if you think back to our
dog washing example from the last video
our rent that we would have to pay on
our space every single month would be a
fixed cost.  It doesn't matter if we wash one
dog or we wash a hundred.  The landlord is
going to want money either way, so
anything that doesn't vary with the
level of output is fixed and anything
that does vary is variable.  So oftentimes
as you increase output you are going to
experience more and more costs.  In our
dog wash example you could think about
this as having to probably hire more
employees in order to get those dogs
washed... buy more supplies.. all of these
kinds of things.  So total costs are
really just a summation... take your
fixed add your variable on top of it and
you're going to get to total. Okay? So
let's go ahead and let's graph are those.
Okay so let's go ahead and graph our costs.  Our fixed cost since it doesn't vary with
the level of output is going to be a
horizontal line, because it doesn't
matter if we're making or we're washing
zero dogs or a thousand dogs our
landlord is going to want to keep
getting paid for rent.  We're going to
have all of our taxes,  our licenses,  any of them that are
fixed payments...let's say it's $3,000 per
month for all of those fixed payments.
UH...Fixed cost is going to consistently have
that same value. Now as we
decide that we're going to go ahead and
wash more dogs we're going to have to
hire more labor, and so variable cost is
going to start going up... and it usually
goes up at a decreasing rate and then
after diminishing returns sets in starts
increasing at an increasing rate... so variable cost is oftentimes going to
have a shape like this one... And of course
total cost is just a summation of the
two of them.  So at any given point we
just need to add on $3,000 on top of the
variable costs,  so we can take this amount
here and we could basically add on
$3,000 here.... and you have a total cost
point.... and you can continue to do that
and you would get a total cost curve and
it's of course going to be parallel to
your vertical...err... your variable costs, but
it's going to be a three thousand dollar
gap at any given Q between variable and
total.  Okay? Hopefully that helps you to
see that.
Now we have to understand are fixed and
our variable and our total cost, but in
those simple forms they're actually not
that useful for graphing and firm
analysis, so oftentimes what we're going
to use are our average versions of them.
Average versions are just, you know costs,
normal costs that are divided by a
specific level of output,  so we make a
hundred units of output... and we have a
fixed cost of three thousand dollars and
a variable cost of two thousand dollars
at a hundred units of output,  then our
average fixed cost is just our fixed
cost divided by the quantity that we're
making.... and our average variable is just
our variable divided by the quantity...
okay?  So this is going to be
mathematically how you would solve for
these if you ever have to calculate it.
And of course you can get average total
cost by dividing total cost by quantity,
or you can just take an average variable
plus average fixed...and adding the two of
them together will get you to average
total cost.... And so these averages are
going to be quite useful.  We're going to
graph them on the next slide.
Okay so let's graph these   We're normally
ever going to graph ATC and AVC, and the
reason its going to work that way is
because if we have those two.... we can
always solve for AFC.  AFC is going to
be the vertical distance between those
two.  So the average total cost curve and
the average variable cost curve are
going to be u-shaped,  and the
vertical distance between them is always
going to be equal to the AFC... and this of
course would be the AFC at this
particular quantity... now since fixed cost
never change but we're obviously making
more and more output.... as we make more and
more output AFC of course is getting
smaller and smaller...
and these two curves are actually going
to get closer and closer together.  My
drawings kind of ugly, but they'll
asymptotically approach zero, so bookmark
these in the back of your brain.  They are
going to be very very useful when we
start analyzing a firm and helping them
decide which quantity they want to
produce.
Okay, one last thing,  we need to talk about
marginal cost because of course our
golden rule is MB equals MC... and none of
our curves so far are dealing with the
MC.  The good news is the MC is derivative of
the total cost curve.  It is essentially
asking how much additional cost happens
when I change output,  ideally when I
change output by one, but you need
calculus to be able to do that,  so this
equation will work for our class. The
easy way to see it graphically is to see
that whenever the total cost curve is
positive but it's getting flatter
through, like this region here, the MC
curve is actually going to be going down.
Still positive cost adding on to what it
costs you to make the product, but the
cost per unit at that point is falling,
okay?
Eventually the total cost curve starts
to increase,  and increase at an increasing
rate,  in other words it starts getting
steeper and steeper like this green
section.  And when that's the case you are
going to see that the MC curves start
shooting up,  like this,  That is always
going to be the sort of general shape
for the marginal cost curve under normal
circumstances,and it's going to be
hugely important for us later.  The last
thing I want to teach you about it is
that it also has a specific relationship
with your average total and average
variable cost.  Your average total cost is
always going to be intercepted
at its minimum point by the MC and that
is also true of the average variable
cost.   The reason that's going to be the
case is because if in fact the MC is
lower than the average it'll drag the
average down... because if the next unit
costs you less than your current average, whatever kind of cost you want to talk
about your AvC or ATC, then the average
of course has to be falling... once the MC
gets above that curve,  then obviously the
next unit is going to cost you more than
your current average and it has to drag
your averages up.  This is kind of like
having an 85 exam score.  If you want your
exam average to go up, then the next exam has
to be higher than an 85.  It's the same thing
here with costs except firms aren't
interested in costs rising.  This just
happens to them because of law of
diminishing marginal returns in the
short run. So we're good now.   We've got
all of our major cost curves taken care
of in the short run... we'll go ahead and
we'll talk about long run in the next
installment.
