TOTAL, AVERAGE AND MARGINAL COSTS

Total cost is the total (entire or all) expenses incurred in the process of production. It is also defined as the ‘sum of total fixed cost and total variable cost’.

Its Curve

The combination of the Total Fixed Cost’s curve and Total Variable Cost’s curve in the same diagram shows a good representation of Total Cost curve as illustrated in figure 5A. However, we can eliminate the Total Fixed Cost curve and construct a single curve to show Total Cost curve as illustrated in figure 5B.

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TC = Total cost.

TFC = Total fixed cost.

TVC = Total Variable cost.

 

Reasons for its shape

Figure 5A simplifies the explanation for the reason of total cost curve’s shape. Certain costs must be incurred whether the firm is functioning or temporarily closed. Such costs are termed as “Fixed Costs.

Fixed costs (FCs) are part of total cost (TC). Thus Total Cost is never zero in a firm except the firm is permanently closed down. Hence total cost curve doesn’t take its original (start) from zero. It remains at a particular level on the vertical axis where output is zero. And such a level coincides with the point where Total Fixed Cost’s curve takes its origin (starts), also on the vertical axis. And it gradually slopes upward as total variable cost increases. Thus total cost’s curve slopes upward from a point on the vertical axis to the right as illustrated in figure 5B.

 

Let us have a look at these questions.

1. When output is zero, what is the value of total cost?

2. When output is zero, what is the value of total variable cost? The answers explain the reasons for their points of origin as indicated above.

Formula

Total cost is calculated with the following formulas:

TC = TFC + TVC

TC = AC multiplied by output (total units produced).

 

Average Total Cost – ATC (or Average Cost – AC)

The concept of average means ‘per unit’, ‘per item’ or ‘per person’. Thus “average cost” means ‘cost per unit’ or ‘cost per item’. Briefly, it is ‘unit cost’. It is obtained by dividing total cost by total units or total items produced.

Calculation of Average Cost (AC)

We can still obtain the average total cost (ATC) in absence of both total cost (TC) and total units produced through the addition of average fixed cost (AFC) and average variable cost (AVC) at a particular level of output. This is the second formula given below:

Formula

The formulas for calculating AC are as follow:-

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  • AC means ‘Average Cost’.
  • TFC means Total fixed cost.
  • ATC means Average total cost.
  • AVC means Average variable cost.

Its Curve

The curve of Average Cost takes ‘U’ shape. It is similar to Average Variable Cost’s curve thoroughly discussed above. The reasons for or proof of the’ shape are the same with that of Average Variable Cost.

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It slopes downward and subsequently swings upward to assume ‘U’ shape.

 

Marginal Cost (MC)

The concept of ‘marginal’ refers to ‘extra’, ‘additional’, ‘one-more’, etc. Marginal cost is therefore defined as follows:

  1. It is additional cost incurred as a result of producing one more item.
  2. It is addition to total cost resulting from production of one extra unit.

 

For example, if the cost of producing 20 tubers of yam is N50.00 and it cost N60.00 to produce 21 tubers of the same yam, the N10.00 difference in cost is known as marginal cost.

Note

We wish to recall that TC = FC + VC. Fixed cost (FC) are permanent costs; they don’t vary with output. Therefore any addition to total cost (TC) results from addition to variable cost (VC). Thus marginal cost occurs as a result of addition to Variable Cost and not to Fixed Cost.

Its Curve

Marginal cost (MC) curve is similar to average variable cost’s (AVC) curve. However, the right hand side is often higher than the left hand side. This is due to indiscriminate employment or uses of additional item.

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Formula

The following formulas are used in the calculation of the MC.

1) Present TC (TC2) minus previous TC (TC1)

MC = TC2 – TC1

2) Change in TC (∆TC) divided by change in output (∆Q).

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