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[music] Alright. So, in this section, we divide everything

Â by, by unit to get a [unknown] unit cost measures, and then we look at how well

Â these curves look like and see if we can get any generalizations on this.

Â Okay, so the first one is fixed cost, and remember that our fixed cost are, don't

Â change. And those are going to be equal always to

Â a $100. So, to calculate the per unit basis, all

Â we do is call that the average fixed costs, the average fixed costs, they're

Â going to be the fixed costs you have divided by the output on a per unit basis.

Â Now, notice that every time you do this, the fixed costs stay the same.

Â What changes is output. So, if you calculate the average fixed

Â costs average fixed costs, you see that at the beginning, they're going to be equal

Â to you know, 100, divided by the output, which is 40.

Â They're going to be 2.50. But when you make more they go down

Â because the, the fixed costs are fixed, you see the, the fixed costs per unit.

Â The average fixed cost when you have 90 units is $1.11.

Â And when you have 120 units, it get smaller, 83 cents.

Â And when you have 135 units, it's even smaller.

Â So, you look at a graph, what's happening here, that is every time you add more

Â workers, your average fix costs go down. Again, your fixed, fixed costs are fixed

Â and your workers are increasing, I mean, and your output is increasing.

Â So, if you put the average fixed cost in a curve with the number of sandwiches in the

Â horizontal axis and the cost in the vertical axis, what you get is the average

Â fixed cost curve which should go down with more output.

Â There's a very interesting application of this as they relate to natural monopolies

Â and the reason we have monopolies controlling public utilities.

Â I have a little video of that at the end of lesson this week.

Â But for now, what we have to remember is that since the fixes are fixed, the

Â average, the fixed customer unit go, go down every time you have more units

Â because you're spreading the overhead among more people.

Â I mean, I mean, more sandwiches. The average variable cost is a whole

Â different story, because the average variable cost will go up at some point

Â because you're paying more workers the same money and it also depends on how

Â productive those workers are. So, to calculate the cost per the variable

Â input, again, what we're going to do, is divide the, the variable cost by the

Â output. And if we do that, you'll see in the table

Â when you have when you have one worker, you make 40 sandwiches, your average

Â variable cost, your cost per worker is $2, and when you have 90 sandwiches, which is

Â when you have 2 workers, your cost is, your average variable cost is1.78.

Â But when you have three cooks, your average variable cost starts to go up to

Â $2 per sandwich. Then, when you have four cooks, it's

Â actually 2.37, which is per sandwich. And then you have fifth cook, and you

Â start to go up at that point. So, it kind of goes down at the beginning,

Â but then it starts shooting up. And again, the reason for that is because

Â of the diminishing marginal product. At some point, you're paying the workers

Â the same money, but they're bringing you less and less output.

Â And then finally, you can take those two measures, the average variable cost, and

Â the average fixed cost, add them together to get the, the total cost per unit, the

Â average total cost. You can also calculate that by simply

Â dividing the total cost by the amount of units.

Â It's the same, you got the same number. And the story should go, I'll, let's look

Â at the numbers first. So, you see that the first the first cook

Â increased to 40 units so the total, the average total cost is 4.50 per unit.

Â Then, with 90 sandwiches with two workers is $2.89 per work per sandwich and then,

Â with 3 cooks, which is 120 sandwiches, you have $2 and $83 of cost per sandwich.

Â And then, with the fourth cook, it starts going up.

Â You see with the 130, with the 135 sandwiches, the cost per sandwich is 3.11,

Â with 140 sandwiches, it's 3.57, and with 142 sandwiches, which is all the cooks, 6

Â cooks, is $4.08. Again, it's not difficult to make that

Â story, right? At the beginning, you know, average,

Â average total cost is made out of average fixed cost and average variable cost.

Â At the beginning, both average fixed cost and average variable cost are going down,

Â are very fickle because you have more unit.

Â And average variable cost because your second worker and first worker were very

Â productive. Now at some point, the average fixed cost

Â stabilize because, you know, they adjust, an, an, a certain amount of workers of

Â units and then, at that point, two things happen at the same time.

Â That, and also the fact that your workers become less productive because they hid

Â this diminishing marginal product problem, they're running into each other in the

Â kitchen, and you're paying them the same. So, at that point, your cost per sandwich

Â is going to start going up rapidly very quickly, alright?

Â So, the average total cost curve is going to go down, and is going to reach a

Â minimum and then it's going to go up, and that should be the way it should look for

Â um,for any kind of operation that follows this problem of diminishing marginal

Â product. And then, finally, let's look at well,

Â before we do that, let's, let's focus a little bit now, on that lower point, the

Â lowest point of the average total cost curve.

Â What does that mean? Well, in the table, that's what, what

Â $2.83, alright? So, when you have three cooks, you'll make

Â 120 sandwiches and at that point, your cost, at least from the numbers from the

Â table, your cost per sandwich is $2.83. That is the lowest cost per sandwich that

Â you are able to get in this operation. The way, the way you're doing your stuff,

Â the best the most efficient point that you are is when you're producing at a cost per

Â unit per sandwich of $2.83. That's not when your costs are the lowest,

Â that is when your cost per unit is the lowest.

Â Which means that if your cost per unit is the lowest, it means that you're doing

Â this in the best possible way. You're using your resources in the best

Â possible way. And per unit, they are the cheapest that

Â they're going to be. So, that is the lowest point of that

Â average total cost curve. Well, as it turns out, if we put the

Â marginal cost curve, which we actually have calculated in the previous section in

Â this diagram, you will see that this marginal cost curve is going to cross the

Â average total cost curve at precisely that point.

Â That's not a coincidence, it's a mathematical property.

Â Now I told you what the importance is of that lower point of average total cost

Â curve. Now, let's see if I can explain the

Â intuition as to why the marginal cost curve crosses that point at the lowest

Â point of the average total cost curve. Well, think about your average for, for a

Â class. So, you're taking a class and your average

Â in the class is 80, 80% and then you take another exam, the marginal is the other

Â exam, and you scored 85 on that exam. So, your average in the class is 80 and

Â your change, your next exam, is 85. What's going to happen to your average in

Â the class? It will go up.

Â Because the marginal, the additional, the marginal change is pulling the average in

Â that direction of the marginal. When the marginal, when the additional

Â exam, the marginal, is higher than your average, your average will go up, it's

Â going up. Now, let's say that you have 80%, on your

Â next exam, it's 70. Now, what, what's going to happen to your

Â average in the class, well it'll go down, right?

Â Because the next exam is 70 and your average of 80 is going to be pulled down

Â by that change of 70% of, in the exam. The same thing with costs.

Â When the point in which marginal cost is lower than average total cost, your, the

Â marginal is pulling your average down. You're getting more productive in your

Â operation. You're getting more efficient in your

Â operation. Now, when the marginal cost is higher than

Â average total cost, they're marginal, every time you produce more units, your

Â average cost per unit will go up, because at that point, you're not very efficient.

Â And you know that you're doing the best, you're at the most efficient point, when

Â both the marginal cost and the average total cost are the same.

Â That is in any, it's a mathematical property.

Â So, that happens for Black Dog and it happens for any business.

Â So, that is very useful information if you're a manager or an owner, right?

Â Because if you want to know the most efficient point of production, then your

Â most efficient point of production is at the point in which your average cost per

Â unit is the same as your marginal cost per unit.

Â Now, what is the significance as to how many workers might you hire for making the

Â sandwiches, and how big is the restaurant should be?

Â That is actually the answers we're going to talk about in the next lesson.

Â Now that we know about cost, we have to bring revenue into the equation price to

Â combine them together in the idea of profits.

Â And that's what we do next week. [music] Produced by OCE Atlas Digital

Â Media at the University of Illinois, Urbana-Champaign.

Â