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Fixed, variable and total costs. What are fixed and variable costs? What costs are called

VARIABLE COSTS

VARIABLE COSTS

(variable cost) Variable costs are that part of costs that changes depending on the level of output. They are the opposite of fixed costs, which are necessary to make output possible at all; they do not depend on the level of output. It should be kept in mind that this is a fundamental difference. The price of a resource used may be stable over the years, but it is still a variable cost if the quantity of that resource used depends on output. The price of other inputs may change, but they will still be considered fixed costs if the amount of inputs used does not depend on the level of output.


Economy. Dictionary. - M.: "INFRA-M", Publishing House "Ves Mir". J. Black. General editor: Doctor of Economics Osadchaya I.M.. 2000 .


Economic dictionary. 2000 .

See what “VARIABLE COSTS” is in other dictionaries:

    - (variable costs) See: overhead costs. Business. Dictionary. M.: INFRA M, Ves Mir Publishing House. Graham Betts, Barry Brindley, S. Williams and others. General editor: Ph.D. Osadchaya I.M.. 1998 ... Dictionary of business terms

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    Variable costs- monetary and opportunity costs that change in response to changes in the volume of output. Together with fixed costs they form total costs. To P.i. include costs for wages, fuel, materials, etc... Dictionary of Economic Theory

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    Costs directly related to production volume, varying depending on volume, for example, costs of materials, raw materials, semi-finished products, piecework wages. Terminological dictionary of banking and financial terms... ... Financial Dictionary

Each enterprise incurs certain costs in the course of its activities. There are different ones. One of them involves dividing costs into fixed and variable.

The concept of variable costs

Variable costs are those costs that are directly proportional to the volume of products and services produced. If an enterprise produces bakery products, then the consumption of flour, salt, and yeast can be cited as an example of variable costs for such an enterprise. These costs will increase in proportion to the increase in the volume of bakery products produced.

One cost item can relate to both variable and fixed costs. Thus, energy costs for industrial ovens on which bread is baked will serve as an example of variable costs. And the cost of electricity for lighting an industrial building is a fixed cost.

There is also such a thing as conditionally variable costs. They are related to production volumes, but to a certain extent. At a small production level, some costs still do not decrease. If a production furnace is half loaded, then the same amount of electricity is consumed as a full furnace. That is, in this case, when production decreases, costs do not decrease. But as output increases above a certain value, costs will increase.

Main types of variable costs

Here are examples of variable costs of an enterprise:

  • The wages of workers, which depend on the volume of products they produce. For example, in a bakery production there is a baker and a packer, if they have piecework wages. This also includes bonuses and rewards to sales specialists for specific volumes of products sold.
  • Cost of raw materials. In our example, these are flour, yeast, sugar, salt, raisins, eggs, etc., packaging materials, bags, boxes, labels.
  • are the cost of fuel and electricity that is spent on the production process. It could be natural gas or gasoline. It all depends on the specifics of a particular production.
  • Another typical example of variable costs are taxes paid based on production volumes. These are excise taxes, taxes under tax), simplified taxation system (Simplified taxation system).
  • Another example of variable costs is paying for services from other companies if the volume of use of these services is related to the organization's level of production. These could be transport companies, intermediary firms.

Variable costs are divided into direct and indirect

This division exists because different variable costs are included in the cost of the product differently.

Direct costs are immediately included in the cost of the product.

Indirect costs are distributed over the entire volume of goods produced in accordance with a certain base.

Average variable costs

This indicator is calculated by dividing all variable costs by production volume. Average variable costs can either decrease or increase as production volumes increase.

Let's look at the example of average variable costs in a bakery. Variable costs for the month amounted to 4,600 rubles, 212 tons of products were produced. Thus, average variable costs will be 21.70 rubles/t.

Concept and structure of fixed costs

They cannot be reduced in a short period of time. If output volumes decrease or increase, these costs will not change.

Fixed production costs usually include the following:

  • rent for premises, shops, warehouses;
  • utility fees;
  • administration salary;
  • costs of fuel and energy resources, which are consumed not by production equipment, but by lighting, heating, transport, etc.;
  • advertising expenses;
  • payment of interest on bank loans;
  • purchase of stationery, paper;
  • costs of drinking water, tea, coffee for employees of the organization.

Gross costs

All of the above examples of fixed and variable costs add up to gross, that is, the total costs of the organization. As production volumes increase, gross costs increase in terms of variable costs.

All costs, in essence, represent payments for purchased resources - labor, materials, fuel, etc. The profitability indicator is calculated using the sum of fixed and variable costs. An example of calculating the profitability of core activities: divide profit by the amount of costs. Profitability shows the effectiveness of an organization. The higher the profitability, the better the organization performs. If profitability is below zero, then expenses exceed income, that is, the organization’s activities are ineffective.

Enterprise cost management

It is important to understand the essence of variable and fixed costs. With proper management of costs in an enterprise, their level can be reduced and greater profits can be achieved. It is almost impossible to reduce fixed costs, so effective work to reduce costs can be carried out in terms of variable costs.

How can you reduce costs in your enterprise?

Each organization works differently, but basically there are the following areas of cost reduction:

1. Reducing labor costs. It is necessary to consider the issue of optimizing the number of employees and tightening production standards. Some employee can be laid off, and his responsibilities can be distributed among the others, with additional payment for him. extra work. If production volumes increase at the enterprise and the need arises to hire additional people, then you can go by revising production standards and or increasing the volume of work in relation to old employees.

2. Raw materials are an important part of variable costs. Examples of their abbreviations could be as follows:

  • searching for other suppliers or changing the terms of delivery by old suppliers;
  • introduction of modern economical resource-saving processes, technologies, equipment;

  • stopping the use of expensive raw materials or materials or replacing them with cheap analogues;
  • carrying out joint purchases of raw materials with other buyers from one supplier;
  • independent production of some components used in production.

3. Reduction of production costs.

This may include selecting other rental payment options or subletting space.

This also includes savings on utility bills, which requires careful use of electricity, water, and heat.

Savings on repairs and maintenance of equipment, vehicles, premises, buildings. It is necessary to consider whether it is possible to postpone repairs or maintenance, whether it is possible to find new contractors for these purposes, or whether it is cheaper to do it yourself.

It is also necessary to pay attention to the fact that it may be more profitable and economical to narrow production and transfer some side functions to another manufacturer. Or, on the contrary, enlarge production and carry out some functions independently, refusing to cooperate with related companies.

Other areas of cost reduction may include the organization's transportation, Advertising activity, reducing the tax burden, paying off debts.

Any enterprise must take into account its costs. Work to reduce them will bring more profit and increase the efficiency of the organization.

FIXED COSTS

FIXED COSTS

(fixed cost) The part of gross costs that does not depend on current production volume. Fixed expenses include management costs and enterprise security costs. Fixed costs in the short term have no impact on profit-maximizing output, but in the long term a firm that is unable to cover its fixed costs will inevitably become insolvent and go out of business.


Economy. Dictionary. - M.: "INFRA-M", Publishing House "Ves Mir". J. Black. General editor: Doctor of Economics Osadchaya I.M.. 2000 .


Economic dictionary. 2000 .

See what “FIXED COSTS” is in other dictionaries:

    - (fixed costs) See: overhead costs. Business. Dictionary. M.: INFRA M, Ves Mir Publishing House. Graham Betts, Barry Brindley, S. Williams and others. General editor: Ph.D. Osadchaya I.M.. 1998 ... Dictionary of business terms

    Fixed costs- FIXED COSTS Costs, the value of which does not depend on the volume of production in the short term. These are lease payments, depreciation deductions, interest on loans and other costs that have to be reimbursed in any case.... ... Dictionary-reference book on economics

    Fixed costs- Costs, the total volume of which is fixed for a given period of time for a given level of production ... Investment Dictionary

    Fixed costs- costs, the size of which does not depend on the volume of production ... Economics: glossary

    Fixed costs (eng. total fixed costs) an element of the break-even point model, representing costs that do not depend on the volume of output, contrasted with variable costs, which add up to total costs... Wikipedia

    fixed production costs- expenses of an enterprise that do not directly depend on the volume of products produced, which cannot be increased or decreased within a short period of time in order to increase or decrease production output. Usually this… … Dictionary of economic terms

    - (average fixed cost) Average fixed costs for a certain period of time incurred by the cost center. At first glance, it seems that there is a contradiction here: if costs are constant, they do not change and, therefore, do not... ... Dictionary of business terms

    conditionally fixed costs- conditionally fixed costs. The dependence of these costs on production volumes has a stepwise nature (for example, the costs of storing materials and finished products). Topics economics Synonyms conditionally... ...

    Production costs are the costs associated with the production of goods. In accounting and statistical reporting they are reflected as cost. Includes: material costs, labor costs, interest on loans...... Wikipedia

    fixed costs- Fixed cost An element of cost or expense that does not depend on the volume of activity in the short term. Also called non-variable or fixed costs. Wed. c Variable Cost.… … Technical Translator's Guide

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 in the best possible way of using them. Opportunity cost is the amount of money required to divert a particular 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 possibility of free access of firms to the industry in the short term is 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 you reach optimal sizes production (Q 1) there is a relative saving of VC.

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 increase in the use of a factor of production, while the rest remain unchanged, sooner or later a point is reached, starting from which the additional use of variable factors leads to a decrease in the increase in production.

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 - a positive effect of 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 firm will have a constant 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, 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 the increase in revenue that arises from the sale of the next 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 total revenues enterprise or firm is equal to the total costs, calculated as alternative. 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.

Previous

Cost price- the initial cost of the costs incurred by the enterprise for the production of a unit of product.

Price- the monetary equivalent of all types of costs including some types of variable costs.

Price- the market equivalent of the generally accepted cost of the product offered.

Production costs- these are expenses, monetary expenditures that must be made to create. For (the company) they act as payment for purchased goods.

Private and public costs

Costs can be viewed from different perspectives. If they are examined from the point of view of an individual firm (individual producer), we are talking about private costs. If costs are analyzed from the point of view of society as a whole, then, as a consequence, there arises the need to take into account social costs.

Let us clarify the concept of external effects. In market conditions, a special purchase and sale relationship arises between the seller and the buyer. At the same time, relationships arise that are not mediated by the commodity form, but have a direct impact on people’s well-being (positive and negative external effects). An example of positive external effects is expenses for R&D or training of specialists; an example of a negative external effect is compensation for damage from environmental pollution.

Social and private costs coincide only if there are no external effects, or if their total effect is equal to zero.

Social costs = Private costs + Externalities

Fixed Variables and Total Costs

Fixed costs- this is a type of cost that an enterprise incurs within one. Determined by the enterprise independently. All these costs will be typical for all product production cycles.

Variable costs These are the types of costs that are transferred to ready product in full.

General costs- those costs incurred by the enterprise during one stage of production.

General = Constants + Variables

Opportunity Cost

Accounting and economic costs

Accounting costs- this is the cost of the resources used by the company in the actual prices of their acquisition.

Accounting costs = Explicit costs

Economic costs- this is the cost of other benefits (goods and services) that could be obtained with the most profitable possible alternative use of these resources.

Opportunity (economic) costs = Explicit costs + Implicit costs

These two types of costs (accounting and economic) may or may not coincide with each other.

If resources are purchased in a free competitive market, then the actual equilibrium market price paid for their acquisition is the price of the best alternative (if this were not the case, the resource would go to another buyer).

If resource prices are not equal to equilibrium due to market imperfections or government intervention, then actual prices may not reflect the cost of the best rejected alternative and may be higher or lower than opportunity costs.

Explicit and implicit costs

From the division of costs into alternative and accounting costs follows the classification of costs into explicit and implicit.

Explicit costs are determined by the amount of expenses for paying for external resources, i.e. resources not owned by the firm. For example, raw materials, materials, fuel, labor, etc. Implicit costs are determined by the cost of internal resources, i.e. resources owned by the firm.

An example of an implicit cost for an entrepreneur would be the salary that he could receive as an employee. For the owner of capital property (machinery, equipment, buildings, etc.), previously incurred expenses for its acquisition cannot be attributed to the explicit costs of the present period. However, the owner incurs implicit costs, since he could sell this property and put the proceeds in the bank at interest, or rent it out to a third party and receive income.

Implicit costs, which are part of economic costs, should always be taken into account when making current decisions.

Explicit costs- These are opportunity costs that take the form of cash payments to suppliers of factors of production and intermediate goods.

Explicit costs include:

  • workers' wages
  • cash costs for the purchase and rental of machines, equipment, buildings, structures
  • payment of transportation costs
  • communal payments
  • payment to suppliers of material resources
  • payment for services of banks, insurance companies

Implicit costs- these are the opportunity costs of using resources owned by the company itself, i.e. unpaid expenses.

Implicit costs can be represented as:

  • cash payments that a company could receive if it uses its assets more profitably
  • for the owner of capital, implicit costs are the profit that he could have received by investing his capital not in this, but in some other business (enterprise)

Returnable and sunk costs

Sunk costs are considered in a broad and narrow sense.

In a broad sense, sunk costs include those expenses that a company cannot return even if it ceases its activities (for example, costs of registering a company and obtaining a license, preparing an advertising sign or company name on the wall of a building, making seals, etc. .). Sunk costs are like a company's payment for entering or leaving the market.

In the narrow sense of the word sunk costs are the costs of those types of resources that have no alternative use. For example, the costs of specialized equipment manufactured to order from the company. Since the equipment has no alternative use, its opportunity cost is zero.

Sunk costs are not included in opportunity costs and do not influence the firm's current decisions.

Fixed costs

In the short run, some resources remain unchanged, while others change to increase or decrease total output.

In accordance with this, short-term economic costs are divided into fixed and variable costs. IN long term this division makes no sense, since all costs can change (that is, they are variable).

Fixed costs- These are costs that do not depend in the short term on how much the firm produces. They represent the costs of its constant factors of production.

Fixed costs include:

  • payment of interest on bank loans;
  • depreciation deductions;
  • payment of interest on bonds;
  • salary of management personnel;
  • rent;
  • insurance payments;

Variable costs

Variable costs- These are costs that depend on the volume of production of the company. They represent the costs of the firm's variable factors of production.

Variable costs include:

  • fare
  • electricity costs
  • raw materials costs

From the graph we see that the wavy line depicting variable costs rises with increasing production volume.

This means that as production increases, variable costs increase:

General (gross) costs

General (gross) costs- these are all the costs at a given time necessary for a particular product.

Total costs (total cost) represent the firm's total expenses for paying for all factors of production.

Total costs depend on the volume of output and are determined by:

  • quantity;
  • market price of the resources used.

The relationship between the volume of output and the volume of total costs can be represented as a cost function:

which is the inverse function of the production function.

Classification of total costs

Total costs are divided into:

total fixed costs(!!TFC??, total fixed cost) - the company’s total costs for all fixed factors of production.

total variable costs(, total variabl cost) - the company’s total expenses on variable factors of production.

Thus,

At zero output (when the firm is just starting production or has already ceased operations), TVC = 0, and, therefore, total costs coincide with total fixed costs.

Graphically, the relationship between total, fixed and variable costs can be depicted, similar to how it is shown in the figure.

Graphical representation of costs

The U-shape of the short-term ATC, AVC and MC curves is an economic pattern and reflects law of diminishing returns, according to which the additional use of a variable resource with a constant amount of a constant resource leads, starting from a certain point in time, to a reduction in marginal returns, or marginal product.

As has already been proven above, marginal product and marginal costs are inversely related, and, therefore, this law of decreasing marginal product can be interpreted as the law of increasing marginal costs. In other words, this means that starting at some point in time, additional use of a variable resource leads to an increase in marginal and average variable costs, as shown in Fig. 2.3.

Rice. 2.3. Average and marginal costs of production

The marginal cost curve MC always intersects the lines of average (ATC) and average variable costs (AVC) at their minimum points, just as average product curve AP always intersects the marginal product curve MP at its maximum point. Let's prove it.

Average total costs ATC=TC/Q.

Marginal cost MS=dTC/dQ.

Let us take the derivative of average total costs with respect to Q and obtain

Thus:

  • if MC > ATC, then (ATS)" > 0, and the average total cost curve of ATC increases;
  • if MS< AТС, то (АТС)" <0 , и кривая АТС убывает;
  • if MC = ATC, then (ATS)"=0, i.e. the function is at the extremum point, in this case at the minimum point.

In a similar way, you can prove the relationship between average variable costs (AVC) and marginal costs (MC) on the graph.

Costs and price: four models of firm development

Analysis of the profitability of individual enterprises in the short term allows us to distinguish four models of development of an individual company, depending on the ratio of the market price and its average costs:

1. If the firm’s average total costs are equal to the market price, i.e.

ATS=P,

then the firm earns “normal” profits, or zero economic profit.

Graphically this situation is depicted in Fig. 2.4.

Rice. 2.4. Normal profit

2. If favorable market conditions and high demand increase the market price so that

ATC< P

then the company receives positive economic profit, as shown in Figure 2.5.

Rice. 2.5. Positive economic profit

3. If the market price corresponds to the minimum average variable cost of the firm,

then the enterprise is located at the limit of expediency continuation of production. Graphically, a similar situation is shown in Figure 2.6.

Rice. 2.6. A firm at its limit

4. And finally, if market conditions are such that the price does not cover even the minimum level of average variable costs,

AVC>P,

It is advisable for the company to close its production, since in this case the losses will be less than if the production activity continues (more on this in the topic “Perfect competition”).