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ii) Average costs: Average cost is a ratio of Total Cost to Total Output units produced. Since total cost has fixed and variable costs as two components, we have three types of average costs. These are average fixed cost, average variable cost and average total cost.

I II III IV V
Production Total (TFC ¸TO) (TVC ¸ TO) (TC¸ TO) = (III+IV)
units output = AFC = AVC = ATC
1 - - - -
2 4 10 2.5 12.5
3 11 3.63 1.82 5.45
4 18 2.22 1.67 3.89
5 23 1.73 1.73 3.46
6 25 1.6 2 3.6
7 26 1.54 2.3 3.84

In the table, column I shows Production Units 1 to 7. Total Output is shown in column II as 4,11…26. In column III we find AFC which is a ratio of Total Fixed Cost to Total Output (TFC¸ TO). Therefore it is determined as 40 ¸ 4 = 10, 40 ¸ 11 = 3.63…etc. Column IV reads Average Variable Cost. It is a ratio of Total Variable Cost to Total Output (TVC ¸ TO). It is obtained as 10 ¸ 4 = 2.5, 20 ¸ 11 = 1.82...etc. Finally, in column V we notice Average Total Cost for different units. It is a ratio of Total Cost to Total Output. (TC ¸ TO). Therefore, it is determined as 50 ¸ 4, 60 ¸ 11…etc. Note that ATC is exactly equal to AFC + AVC. The alternate method of computing ATC is to add the values in columns III and IV.

The behavior of the three average cost varieties is an interesting and important part of Cost Analysis. We are mainly interested in the behavior of ATC (column V) which has two components, AFC and AVC. The behavior of ATC is jointly determined by AFC and AVC. AFC continuously falls. Therefore AFC tends to pull AFC in its own direction and causes its fall. AFC falls sharply in the initial stage from 10 to 3.63 but it slows down in its rate of fall towards the end such as from 1.60 to 1.54. The effect of the fall in AFC is the progressive reduction in the value of ATC. AVC initially decreases from 2.5 to 1.82 to 1.7 but it subsequently rises from 1.67 to 1.73 to 2 to 2.30. The effect of AVC on ATC is initially reductive but when it starts rising, it attempts to pull ATC in its own direction. ATC initially falls sharply from 12.5 to 5.45 to 3.89 when both AFC and AVC reduce in value. Then it becomes moderate in its fall us present the cost curves with the help of diagrams to gain further familiarity with them.

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Index

9.1 - Concept of a Firm
9.2 - Factors of Production and Product Output
9.3 - Costs and Profits
9.4 - Costs Analysis

Chapter 10

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