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>> Alright.
Welcome back to chapter 6, tenth number 2
where we're talking about cost analysis.
So one of the things that we're trying to do is to get
to nomenclature set up.
So one of the things that I do is abbreviate total cost,
variable cost and fixed cost with these letters,
it's standard abbreviation
so you should probably get used to it.
And one of the other things that what you should realize is
that total cost will always be the variable cost plus the fixed
cost and again, these are short run terms.
In the short run, you have variable costs
and you have fixed costs and if you wanted to have another graph
of these types of costs, here is sort of a cost analysis
on a dollar amount versus the number of units produced.
Notice that fixed cost is straight line across, fixed,
so it doesn't change for each unit that you produce.
Variable cost, notice that it's zero
when you don't produce anything but as you produce each unit,
each unit costs a certain amount to produce,
and then total cost is just the sum of each one of those things
where you're gonna have a certain amount
of fixed cost regardless of how many you produced
from your fixed cost or just anything that it costs you
to run a business regardless
of whether you're actually producing anything,
so things like rent, things like mortgage payments that you have
to make on a loan that you have, all of that kinda stuff,
that's fixed regardless where you can produce one unit.
Now these curves, they're nice curves.
They're good for setting the table but beyond that nah.
We don't use them for anything else
so it's no point keeping 'em around so let's get rid of 'em.
But we'll be using in a regular basis are these curves,
the average total cost, ATC
and the average total cost is a formula
that is the total cost divided by the amount of units
that you've produced, right?
So in the beginning you start, you know,
your average total cost goes down because you start
to produce more and easier to produce a whole bunch more
but eventually, yeah, you get to this point where you've max--
you know, minimized the amount of cost that you can produce
that and in order to produce more,
it's gonna cost you more per unit.
Similarly, this is average variable cost
where you've just removed the fixed cost.
Again, it's the same type of formula.
You take the variable cost and divide it by the actual quantity
and the interesting curve that's right here is the marginal cost.
Marginal cost, that's one of the curves
that we're gonna be looking
at in a regular basis throughout the rest of the chapter.
Marginal cost is the additional total cost
when you produce one more unit and the reason you wanna look
at that so closely is that that's the analysis you use
to determine whether or not to produce one more unit.
If you produce one more unit and it costs you more
than you're gonna sell that for should you produce it,
so don't, alright?
So marginal analysis, that's something we'll get
to in a little bit later and the marginal cost is something
that we'll use in order to do that.
Well, we won't get to that until we get
to actually looking at revenue.
So for now, just realize this is the way it looks.
Alright, now this is all short run analysis, alright?
We haven't looked at anything in the long run.
Well let's consider that though just a little bit
and see what we see, alright?
So let's look at it from the long run analysis.
In the long run, you could produce lots and lots of units
if you think you really want to, right?
You could build a factory that's, you know,
as big as the entire city of Gainesville, right?
If you really wanted, you could try and do it.
If you'd find enough land, find enough people to hire to come
and build you that number of buildings, right?
So when you first start producing,
you'll build a small factory
and here's what your average total cost curve looks
like in a small factory.
You realize we've spread this out, right?
This is a much longer curve than over here.
This-- the number of units
over here may be only a million [noise] whereas the number
of units over here on this curve is something
like [noise] 100 billion, right?
You could really truly get carried away.
And so, this is the way your average total cost curve goes
and you're producing say right here.
So the price is somewhere up here.
So you're making profit and it's good but the cost,
the average total cost has hit this curve
when it's turning around, right?
It's starting to cost more to produce.
Probably what's happened here is that, you know, let's imagine
if you're building four toreses, right?
This is what your average total cost curve would be
if you only had say one shift, one shift working
and it would only-- you know, it would produce any maximized
or a minimized cost right down here.
But since the cars costs so much and you can sell 'em so much,
you wanna produce more
and so you keep pushing those people up.
You hire a second shift, maybe you even hire a third shift
and you start giving those people over time to come back
and produce 'cause they're really good at it and what ends
up happening is that you gather all of your accountants
and your smart people, your economists and they say,
you know, looking at your business,
this is what your average cost is.
If you throw away this old factory that you have,
which is nice but it's too small and you build a bigger one,
[pause] here is what your average total cost would be
for a bigger factory.
Allow the size of your factory to change.
In the short run, that's a fixed cost.
In a long run, nothing's fixed.
So we've allowed it to change.
Notice what happens.
Notice what would happen
if you actually build that bigger factory.
Your average cost for producing as many cars as you are,
goes down drastically.
This is exactly what people are looking at when they're trying
to determine when to change the size of a factory.
Their average total cost curve's gonna keep going
up and up and up.
Once it gets above the price, that's when they start looking
at building a bigger factory and this gives you a bit
of an overall look at what's going on in the long run.
Now let's suppose that we put all of these, you know,
sort of average total cost curves together
and let the variation of the size
of the firm be truly variant for all time,
this is the way the long run average total cost curve looks.
In other words, if you took all of those short run curves
and got the minimum point on them,
this is where the way your curve would look, right?
It would keep going down and then would start flapping out.
Well the reason that we talk about this is that is this area
of the curve, this [noise] isn't called economies of scale.
This is where the average total cost curve is decreasing.
This is where we're taking advantage of specialization.
People are specializing in doing one piece of the work
and make it really good at producing that one piece
and they keep doing it over and over again, they could do it
for about 7 or 8 hours and then it's good for the day
but they produce it at the best possible rate.
You don't have to try and do every job equally
as well though they pick one specific one and do it.
That's when you experience your economies
of scale, specialization.
[Noise] What you're getting here
where your long run average total cost curve isn't changing
too very much, it might be going down just a little bit inside
of there and then starting to go
up just a little bit towards the end
but basically it's staying even.
[Noise] Basically here's when you're getting constant
and that's an N in there, returns to scale.
Basically the average total cost curve isn't going
up or down at all.
It's basically staying roughly the same and so, you're constant
so that as you produce more,
you're not necessarily being able
to produce it at a cheaper cost.
It's basically gonna stay the same
and if your price is somewhere up here,
you still wanna be doing
that because you're making money, right?
Every time the price is above the average cost,
that's profit, alright?
And the last stage where you're starting to lose money, right,
where you're starting-- well not lose money,
I shouldn't say that.
This is just where the average total cost starts
to increase per unit, this is called diseconomies [noise]
of scale and this is where you've got such a huge company
that there's just no way you can keep everybody on the same page.
Imagine if you really are looking at say IBM.
In the very beginning, IBM had very good economies of scale,
right, when they were building computers the very first time
and they were really only building computers
in the United States when they first started, right?
And they started expanding.
They started expanding from being just in Silicon Valley
to all around the California area.
They moved into New York.
They moved into Chicago and the midwestern.
They had firms all over the place, right?
And they also branched into consulting and their economies
of scale kept decreasing and decreasing.
Well they kept growing, alright?
They expanded.
They expanded into Canada.
They expanded into Mexico.
They started to get to the stage where there are constant returns
of scale but now IBM is huge.
It's got factories in India, Russia, Brazil,
Africa, Europe, you name it.
Practically every country has got an IBM either think-tank
or workshop somewhere in the world.
Well how does IBM keep all of those people on the same page?
How do they all know what IBM wants them to do?
There's really only one centralized office.
How do they do it?
They spend a lot of money doing it.
That's where those diseconomies of scale come from.
Basically you've gotten so big,
you've got so many cooks you spoil the broth, right?
So keep in track of-- keep track of what economies of scale are
and what diseconomies of scale are and we'll sort of get back
to that a little bit later when we start talking
about monopolies 'cause this thing actually plays a part.
So there's a long run analysis of our perfect competition
or of our production costs.