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## Short-run production costs

Current time:0:00Total duration:6:27

# How costs change when fixed and variable costs change

AP Micro: PRD‑1.A.3 (EK), PRD‑1.A.4 (EK), PRD‑1.A.5 (EK), PRD‑1.A.6 (EK), PRD‑1.A.7 (EK)

## Video transcript

- [Instructor] In the last few videos, we were studying our watch factory, ABC Watch Factory. And based on some data, knowing what our fixed costs are, our labor units, our variable costs, our total costs, and then our total
output, and that would be for for different amounts of labor, we were able to calculate
marginal product of labor, marginal costs, average variable cost, average fixed cost,
and average total cost. What we're gonna do in
this video is start to explore how these various calculations will change, and
eventually, how these curves will change based on changes
in cost and productivity. So let's say our rent has
gone up by $2000 a month, and we have to pay that extra rent regardless of what our output is. So what is that going to do
to marginal product of labor, marginal costs, average variable cost, average fixed cost,
and average total cost? Pause this video and think about what's going to happen before
we actually model it in this spreadsheet by
raising our fixed costs, our monthly fixed costs. So we are going to go from $5000 a month of fixed costs to $7000
a month of fixed costs. So it's gonna be $7000,
but we're not done yet. We want to scroll all the way down. And so, what changed
from what I had before? Well if you were paying close attention, your marginal product
of labor hasn't changed, your marginal cost hasn't changed, your average variable cost hasn't changed, your average fixed and
average total cost did change. And that should, hopefully,
make intuitive sense. If you look at the
formulas for these things, for example, the marginal
product of labor, you would see that it
involves total output and the labor units. It doesn't involve the fixed costs at all. So if the fixed costs
change, you wouldn't expect our marginal product of labor to change. When you look at marginal costs, you are involving total costs. And you say hey, isn't fixed costs part of total costs? But remember, fixed cost is, the $7000 is part of the $13000, and it's part of this $9000 right over here. So when you take the
$13000 minus the $9000, which we do in the
numerator right over here, we're doing our change in total costs over our change in output, those two $7000 cancel out. The fixed costs cancel out,
and so your marginal costs is not dependent on your fixed costs. Similarly, your variable
costs is separate, you can view in a lot of
ways, from your fixed costs. So your average variable
costs aren't going to be affected by fixed costs. And, of course, you would expect your average fixed costs to change, because that is directly derived from your fixed costs and your output. And then, average total
costs are also derived from total costs. It's not a change between total cost, and that total cost has
the fixed cost in it. So you might be asking yourself, well what would change your
marginal product of labor, your marginal costs, your
average variable cost, or your average total cost? Well, think about a change
in labor productivity. Let's say that each person,
there's some magical new device, or new
process, that allows them to be a little bit more productive? Well then one person,
instead of producing 10, let's say they now produce 11. And let's say two people
now, instead of 25, can now producer 27. Let's say three people, instead of 45, can now produce 47. And now four people, and
I'm making these numbers up, they can no produce 59. Lemme say this is 66. And then let's say that this is 72. And so notice, that did change our marginal product of labor. And once again, marginal product of labor is based on the difference
in total output, as we have a difference
in our labor units. And that change in productivity, it might be more pronounced. In the way I just happened
to pick the numbers, it was more pronounced
when you have fewer people, and then it got more diminished as you had more and more people. But when you had that
change in productivity, you might have noticed that that changed our marginal cost, and that changed our average variable cost. Because, once again, your marginal cost, if we look at it right over here, it is calculated by looking at your change in total cost,
divided by your change in total output. And when we had this
productivity improvement, our change in total output improved. Now there could be a
situation where you have a productivity improvement, but the change in total output from
one person to the next, might not change. So it's not always going to change either the marginal product of
labor or the marginal cost. But changes in productivity will often change those two things. And similarly, if you look at your average variable
cost, it is based on your variable costs and your output. When you have this
productivity improvement, that's going to improve your output for any given amount of variable cost. And so, that's going to have an affect on your average variable cost. And then your average
total cost is, of course, based in part on your total variable cost, which is driven by that
productivity improvement. Similarly, you could have
changes in variable cost. Let's say all of the people who work at your factory have
gotten together and say we want a raise. And you give in, and you give a raise, well now, instead of $2000 per worker, it's going to cost $2200 per worker. You gave a 10% raise per month. And so let me get that all the way down. And notice, the things that you would have expected to change did change. Your marginal product
of labor didn't change, because marginal product of
labor is not driven by cost. It only looks at the labor
units and the total output. But your marginal cost did change, even though our output for every incremental person did not change, because the underlying
cost of the people changed. Similarly, the average variable cost, you would of course expect it to change, 'cause our variable
costs all went up by 10%. Your average fixed cost isn't going to be affected, 'cause we changed the variable cost, not the fixed. And the total costs were,
of course, affected, because the average
variable cost were affected.

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