Lecture 11
COST FUNCTIONS

• Total, Fixed and Variable Costs
• Average Cost and Marginal cost

1. Total cost (TC)

The (minimum) total cost of producing a given level of output, Q

1. Fixed cost (TFC)
   • Portion of total cost that is independent of i
   • Includes factory rent, utility bills
2. Variable cost (TVC)
   • Portion of cost that varies with output
   • Includes labor cost (wages paid to workers)

2. Average cost (AC)

• Cost per unit of output: AC = TC/Q
• Average fixed cost: AFC = TFC/Q
• Average variable cost: AVC = TVC/Q
• Question: What is the relationship between AC, AFC and AVC?

3. Marginal cost (MC)

• Additional cost incurred in producing 1 more unit of output
• On a sketch of AC and MC curves, MC will pass through the lowest point on AC
  • If MC < AC, producing 1 more unit of output will reduce average cost: AC will fall
  • If MC > AC, producing 1 more unit of output will increase average cost: AC will rise