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Exam: Dec. 2014 Level 1 > Study Session 4. Economics: Microeconomics Analysis > Reading 15. Demand and Supply Analysis: The Firm
Learning Outcome Statements
15.d. calculate and interpret total, average, marginal, fixed, and variable costs;
Subject 3. Cost measures.
Factors of Production A firm is an institution that hires factors of production and organizes them to produce and sell goods and services. Such factors include land, labor, capital, and materials. The total product curve shows how total product changes with the quantity of variable input employed.
- Total Fixed Cost. The sum of the costs that do not vary with output. They will be incurred as long as a firm continues in business and the assets have alternative uses. Examples of fixed costs include rent, property taxes and insurance premiums.
- Average Fixed Cost. Total fixed cost divided by the number of units produced. It always declines as output increases.
- Total Variable Cost. The sum of those costs that rise as output increases. Total variable costs are zero if output is zero. Examples are wages paid to workers and payments for raw materials.
- Average Variable Cost. The total variable cost divided by the number of units produced.
- Average Total Cost. Total cost divided by the number of units produced. It is sometimes called per unit cost. ATC is high at low levels of output, decreases as output increases (since fixed costs are spread across more units), and then increases as the firms maximum capacity is approached (since marginal costs increase).
- Marginal Cost. The change in total cost required to produce an additional unit of output.
The law of diminishing returns implies that the marginal costs of producing each additional unit would increase by increasing amounts. Initially, as output expands, the cost of producing each additional unit of output falls, but then begins to rise as the firm approaches its maximum capacity (e.g. too many workers, congested production lines).
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