![]() The result can be greater increasing marginal returns. A second barber reduces the level of disruption from jumping back and forth between these tasks, and allows a greater division of labor and specialization. The single barber needs to do everything: say hello to people entering, answer the phone, cut hair, sweep up, and run the cash register. To understand the reason behind this pattern, consider that a one-man barber shop is a very busy operation. For example, as the number of barbers rises from two to three, the marginal output gain is only 20 and as the number rises from three to four, the marginal gain is only 12. From that point on, though, the marginal gain in output diminishes as each additional barber is added. As the number of barbers increases from zero to one in the table, output increases from 0 to 16 for a marginal gain of 16 as the number rises from one to two barbers, output increases from 16 to 40, a marginal gain of 24. This is caused by diminishing marginal returns, discussed in the chapter on Choice in a World of Scarcity, which is easiest to see with an example. While variable costs may initially increase at a decreasing rate, at some point they begin increasing at an increasing rate. You can see from the graph that once production starts, total costs and variable costs rise. The fixed costs are always shown as the vertical intercept of the total cost curve that is, they are the costs incurred when output is zero so there are no variable costs. The relationship between the quantity of output being produced and the cost of producing that output is shown graphically in the figure. As production increases, variable costs are added to fixed costs, and the total cost is the sum of the two. ![]() At zero production, the fixed costs of $160 are still present. So, for example, with two barbers the total cost is: $160 + $160 = $320. Adding together the fixed costs in the third column and the variable costs in the fourth column produces the total costs in the fifth column. For example, two barbers cost: 2 × $80 = $160. These are calculated by taking the amount of labor hired and multiplying by the wage. The fourth column shows the variable costs at each level of output. The third column shows the fixed costs, which do not change regardless of the level of production. The first two columns of the table show the quantity of haircuts the barbershop can produce as it hires additional barbers. The variable costs are the costs of hiring barbers, which in our example is $80 per barber each day. The fixed costs of operating the barber shop, including the space and equipment, are $160 per day. The data for output and costs are shown in Table 2. Variable costs would also include raw materials.Īs a concrete example of fixed and variable costs, consider the barber shop called “The Clip Joint” shown in Figure 1. Labor is treated as a variable cost, since producing a greater quantity of a good or service typically requires more workers or more work hours. ![]() Variable costs, on the other hand, are incurred in the act of producing-the more you produce, the greater the variable cost. The level of fixed costs varies according to the specific line of business: for instance, manufacturing computer chips requires an expensive factory, but a local moving and hauling business can get by with almost no fixed costs at all if it rents trucks by the day when needed. Fixed costs can take many other forms: for example, the cost of machinery or equipment to produce the product, research and development costs to develop new products, even an expense like advertising to popularize a brand name. Once you sign the lease, the rent is the same regardless of how much you produce, at least until the lease runs out. One example is the rent on a factory or a retail space. Whether you produce a lot or a little, the fixed costs are the same. Fixed and Variable Costsįixed costs are expenditures that do not change regardless of the level of production, at least not in the short term. ![]() ![]() When a firm looks at its total costs of production in the short run, a useful starting point is to divide total costs into two categories: fixed costs that cannot be changed in the short run and variable costs that can be changed. However, the cost structure of all firms can be broken down into some common underlying patterns. A list of the costs involved in producing cars will look very different from the costs involved in producing computer software or haircuts or fast-food meals. The cost of producing a firm’s output depends on how much labor and physical capital the firm uses. Evaluate patterns of costs to determine potential profit.Analyze short-run costs as influenced by total cost, fixed cost, variable cost, marginal cost, and average cost. ![]()
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