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Video transcript

- [Instructor] In the previous video, we began our study of ABC Watch Factory and we tried to understand the economics of the business based on some data that we had already collected on our costs and how much output we could produce based on how many labor units we had. And then from that, we calculated things, like the marginal product of labor, the marginal cost, the average variable cost, the average fixed cost, and the average total cost. What we're going to do in this video is take this information, especially total output and all of these things that we just calculated, so that we can better appreciate how these various calculations and the curves that we can get from the calculations are interrelated, so let me scroll over a little bit so we have some space and then let me set up a little coordinate plane here. And so what we have on our vertical axis, this is our cost, and then down here, in our horizontal axis this is our output. So, first let's just hand graph it, and I encourage you to go through the exercise yourself. It's one thing to watch me do it, but when you actually graph something you digest the numbers that much better. And so, let's start with marginal cost. And I'm going to do it in this blue-green color. So let's see, when our total output is 25, our marginal cost is 267. So, when our out put is 25, 267 would be right about there. And we're just trying to get, be able to visualize what's going on. And then, when our total output is 45, our marginal cost is $150. So 45 is here and then 150 is right about there. And then when our total output is 58, our marginal cost is 231. So 58 is right about there, and then it's gonna be 231, so it's about, right about there. And then, when our total output is 65, our marginal cost is 429, so the 65 is right over there and then 429 will get us right about, right about there, so you see our marginal cost is going up a lot now, it might be a little bit lower than that, so it's gonna be right over there. And then last but not least, when our total output is 70, our marginal cost is $600. So at 70 we get to 600 and I'm eyeballing it, that's not exact graph paper, but this gives you a sense of what the marginal cost curve looks like. And here we've kinda graphed it based on where we are in terms of output. So, that's our marginal, marginal cost curve. So I'll just label that marginal cost. And now let's see how that relates to the curves for average variable cost and average total cost. So average variable cost I'll do in this orange color. So, at an output of 25, our average variable cost is $240. So 25, we are going to be at $240, which is right about, right about there. And then when we are at 45 units, our average variable cost is 200. So at 45, units our average variable cost is right over there. And then at, we did that one. And then at 58 units, it's $207. 58 units, it is 207, so it's going to be right about there. And then at, we did this one. And at 65 units, it's 231. 65 is, and then we get to 231 which is right maybe about there. And then, this we did this one, and then at 70 units, we're at 257. So 70 units, 257 looks something like this. Now, before I actually draw into this scurve, connect the dots, so let's just think about how the average variable cost relates to the marginal cost. When the marginal cost is less than the average variable cost, well that means that as we produce more and more, our average variable cost should go down, and we see that happening in this early stage. I won't go into all the details on what's happening exactly right over there, but that early stage, as we see that while our marginal cost is less than our average variable cost, our average variable cost is trending down. And that makes sense. Every incremental unit is a little big cheaper to produce, so it brings down the average. But as soon as the marginal curve crosses the average variable cost and the marginal cost, every incremental unit is now more than the average, well that should bring up the average. And so then the average variable cost should start sloping up. So, it's good to realize, one is a rule of thumb but even more important to realize why, that where the marginal cost curve and the average variable cost curve intersect, that that's going to be the point at which the average variable cost goes from trending down to trending up. If you viewed as this very wide U shape, that would be the bottom of the U. And we can do the same thing thing with average total costs. Now, they're going to cross a little bit later because the average total costs are higher because they're factoring in the fixed costs as well, but you can imagine that while your marginal costs are lower than your average total costs, every incremental unit is going to bring down the average total cost, but as soon as the marginal cost crosses the average total cost, it's gonna start bringing up the average. And we can see that by trying to graph average total cost, and I'll do that in this yellow color. So, at 25 units, we're at 440. 25 units, we're at 440 that makes sense 'cause we have all that fixed cost that we're spreading along amongst not that many units. And then at 45 units, we're at 311. 45 and we get to 311, might be right around there. Then at 58 units, we're at 293. 58 units, we are at 293, which is right about there. And then at 65 units, we're at 308. 65 units, we are at 308. And then at 70 units, we're at 329. 70 units, we are at 329, so it maybe something like this. And so this is our average total cost. And just as you can imagine, while your marginal costs, every incremental unit, the cost of that, is less than your average total cost, it'll bring down, when you do that incremental output, it will bring down your average total costs until the point that they cross and then, now, after you, after these two curves cross, now every incremental unit is bringing up the average cost, 'cause it's costing more than the average. And so, once again, where these two curves intersect, if you view the average total cost curve where there's this big wide U, it would represent the bottom of the U. Now, the last thing that we didn't graph, and this is maybe the most intuitive, is the average fixed cost. And this is just going to asymptote down. At 25 units, we're at 200. 25 units, we are at 200. At 45 units, we are at 111. 45, 111, it's maybe right over there. At 58 units we're at 86. 58 units, 86. At 65 units, we're at 77. 65 units, 77. And then at 70 units, we're at 71. And so you can see that that just gets lower and lower and lower over, as you produce more and more output because you're able to spread those fixed costs amongst more and more output, so that makes sense that the average fixed costs just trends downward like this the entire time. But the big take-aways here is not just to understand the rule of thumb that where the marginal cost curve intersects the average variable cost or the average total cost, that that's the, you could view it as the minimum point of the average total cost or the average variable cost curves, but to understand why that is happening.