1. Bob the Builder Example
Cost Curves
Bob the Builder Example

2. 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

3. 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

4. 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

5. 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) = ( ) / 140 = $3/brick

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. Putting it all together…