Lecture 6 - Friday, February 16, 2018

Monday, February 12, 2018 8:46 PM

Analysis of Operational Costs

Any project has a life time, it is not meant to live forever.
For a project to live longer, it needs injection.

Construction Operation
Time Time

Project
Start Operational Cost
Constructional Cost point
(Investment Cost)

Finance Variable Costs

Fixed Costs
FC VC
Capital --> Assets Directly linked
Fixed
payments t the level of
* Investment costs production
regardless
determine the (Energy costs -
the output
capacity of the Raw
operation Materials ..)
It may equate
Zero
VC α Output

Total Costs

In the Short-run:
Total Costs = Total Fixed Costs + Total Variable Costs
TC=TFC+TVC at each level of production

Since TFC are constant, then the attitude of TVC shapes the attitude of TC
TC and TVC are identical, but they are separated by the TFC (5)
➢ It is observed that the total costs with the level of output were
increasing, then the total costs slowed down (increase with decreasing
rates) (between 2 - 3), and then the total costs started to increase
dramatically (increase with increasing rates). (which is not a good
sign for producers)

Marginal Cost
Like The Marginal product, the marginal costs measure the effect on the

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Like The Marginal product, the marginal costs measure the effect on the
difference of the total costs as a result of producing an additional unit.
Hence, MC=
*It is very important in decision making*
From the supplier side, they will not bear huge
costs if another passenger joined a plane with
some empty seats, unlike a case of fully occupied
plane. In that case, the supplier would have to
prepare another plane with another crew and
fuel (extra costs from the supplier side)

Average Costs
AC identify the contribution of costs on the quantity supplied. Let's say that
I am a supplier, and I produce a car as a product. Consider a car, for
simplicity, to be made of wheels, Body and a motor. My variable factor is
the level of production (which is linked to the number of labors), so if I
want to increase my total output, I will assign more labors for each part of
the car (wheel - body - motor), which means I will pay more per unit
production (MC). So the average cost that I would bear will be the costs
paid/ the number of production.

➢ In the previous example, it was only mentioned the variable costs

(directly related to the level of output), so the average cost in that case
would be Average Variable Cost. However, there is also a fixed cost.
From here, it can be said that there is:
Average variable cost
Average Fixed cost
Average Total cost

AFC = FC at no production (Q=0)

*Average cost is very important to me as a supplier, because it is the

foundation, on which I can price (Pricing) the product for customers. The
product price for customers must cover my average costs (AVC and AFC), Deduced from the change in
otherwise I would be making a loss. total costs and the change
of number of labors

From that table, I can deduce Table (4-3)

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Notes
1. Again, since MC is very specific, it controls the
attitudes of the AVC, and ATC

Minimum ATC

Minimum AVC
That means that at those points, the difference
in cost per unit output before the minimum
points would be the same after the minimum
points.

Cost Minimization is achieved when MC

Keep in mind: equals ATC
1. The case when MC = AVC, not ATC is called a
survival case, in which the AFC has to be covered
from my pocket. Whenever the AVC would not be
covered by the MC, I am achieving a loss.
---------------------------------------------------------

What is the relation between Marginal Product and

Marginal Product?

As we noticed in the previous section, Marginal Cost is

related to the Level of production, which is related to the
number of labors, there has to be some relation between
Marginal Cost and Marginal Product.

My aim as a supplier is to achieve maximum output

(translated to profit) at MP ~ 0 (but positive), and MC=AVC

Ex:
I have a fixed factory and a fixed capital, and I want to
manufacture chairs. I will assign the first labor, and he
will make X output. He made a huge difference in the
output (high MP), and my cost will be huge referred to the
level of output (High MC). By assigning the second labor,
his addition related to the level of output would tend to be
greater than the first labor (increasing MP), while my
average total cost related to the level of production would
tend to be less (decreasing MC). This would continue until

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tend to be less (decreasing MC). This would continue until
the end of phase 1.
Starting from phase 2, where the factory become fully
occupied, but still the level of production could increase,
the MP would tend to decrease, and at the same time the
MC would tend to increase.

From here we can say that there is an inverse relationship

between MP & MC

Phase 1| Phase 2

W: price of the
variable Factor

Production Function, Costs and Optimal decisions

What do I need to know in order to make an efficient decision?

➢ I need to know MP Vs. Number of labors
➢ I need to know MC Vs. ATC

1st: MP Vs Number of Labors

Number Output MP
of
Labors

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1st: MP Vs Number of Labors
Number Output MP
of
Labors
0 0 --
6 1 0.16
11 2 0.2
15 3 0.25
21 4 0.16
31 5 0.1
45 6 0.07
63 7 0.05
85 8 0.02

The Marginal product curve tells me that I can produce until 85 labors
with no problem (there is no phase 3 as long as MP is not negative)

2nd: MC - ATC Vs. Output

Level of Fixed Cost (Land Variable Cost (Number Total ATC MC

Output Price/acre * acres) of Labors * Price/Labor) Cost
0 55 0 55 -- --
1 55 30 85 85 30
2 55 55 110 55 25
3 55 75 130 43.3 20
4 55 105 160 40 30
5 55 155 210 42 50
6 55 225 280 46.6 70
7 55 315 370 52.85 90
8 55 425 480 60 110

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Therefore at Number of Labors of 21, I Can achieve the most
efficient output with minimum costs

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