Bob the Builder Example Cost Curves Bob the Builder Example

Cost Curves: Bob the Builder Example Total Cost To employ Bob to work the firm needs to pay $420 Every additional worker is $420 Bricklayer Total Cost 1 $420 2 $840 3 $1260 4 $1680 5 $2100

Cost Curves: Bob the Builder Example Total Product When Bob begins laying bricks he adds 70 to the wall When a second friend begins, the total product increases to 210 bricks. Worker 6 adds less bricks Bricklayer TP MP 1 70 2 210 140 3 420 4 630 5 770 6 840

Cost Curves: Bob the Builder Example Average Costs Because Bob is not very productive by himself, the cost per brick is very high at $6 By adding extra workers, the average cost per brick falls due to the increased efficiencies, division of labor, specialization, etc. Bricklayer Total Cost TP Avg Cost per brick = TC/TP 1 $420 70 6 2 $840 210 4 3 $1260 420 $1680 630 2.67 5 $2100 770 2.72 $2520 840

Cost Curves: Bob the Builder Example Marginal Costs If Bob’s boss wants to add one more brick to the fence, he has to pay a small amount. This is called marginal cost. Bricklayer Total Cost TP Avg Cost per brick = TC/TP MP MC per brick ($) 1 $420 70 6 2 $840 210 4 140 3 $1260 420 $1680 630 2.67 5 $2100 770 2.72 $2520 840 MC per brick $ = (Total Cost now – Total Cost previous / Marg. Prod. One more brick for 2 workers: MC (2) = (840-420) / 140 = $3/brick

Cost Curves: Bob the Builder Example Fixed Cost The firm where Bob works needs to pay some costs regardless of the level of building that is occurring This is sometimes called sunk cost Bobs firm must pay these fixed costs. General Managers salary Lease the digger and crane Pay insurance Pay for a phone rental

Cost Curves: Bob the Builder Example Average Fixed Cost These are calculated by dividing fixed costs by the output of the firm. If Bobs firm makes two fences the AFC is $60 Output (Q) Fixed Costs AFC 120 1 2 60 3 40 4 30 5 24

Cost Curves: Bob the Builder Example Average Variable Costs These are the costs that increase as output increases As Quantity produced increases…variable costs increase Bills that relate directly to level of output Eg. Cost of raw materials, wages, electricity bills, gasoline Variable Cost / Output = Average Variable Cost Output Variable Costs Avg. Var. Cost 1 30 2 50 25 3 63 21 4 76 19 5 95 6 120 20

Cost Curves: Bob the Builder Example Average Total Costs This is the sum of Variable Costs and Fixed Costs TC = FC + VC ATC = AFC + AVC ATC = TC / Output

Cost Curves: Bob the Builder Example Bringing it all together … what to costs look like? FC = Constant VC = Increases with output TC = Decreases with output AFC = Decreases with output AVC = U shaped ATC = U shaped MC = U shaped/Nike swoosh

Putting it all Together FC = Constant VC = Increases with output TC = Decreases with output AFC= Decreases with output AVC= U shaped ATC= U shaped MC= U shaped/Nike swoosh

Putting it all together…. Marginal Cost Curves……. Where does MC cross? Cuts AVC at minimum Cuts ATC at minimum When increasing returns – MC must fall When decreasing returns – MC must rise. Diminishing Marginal Returns

Putting it all together…