[MUSIC] So we've introduced the concept of marginal cost and we said it first goes down and then increases. But the marginal costs are of course a reflection only of the variable cost. They are a reflection of the cost of labor in my example of making t-shirts. What about these fixed costs. Where do they come in? We could also go ahead and graph the average cost of producing a t-shirt. And the average cost would include both the average cost of labor and the average cost of the fixed input such as capital. If we go ahead and draw the average cost curve, it will have a shape more or less like this. So this is the average total cost and what I'm saying is the following. In the beginning, the average costs go down, but after a while the average costs increase. Why is that? In the beginning the average costs decline because the same fixed cost is divided over a bigger and bigger quantity. Think of the cost of setting up the factory to make t-shirts. Maybe that cost is half a million dollars. If you only made one t-shirt, the average cost would be half a million dollars. If you made two t-shirts it would be 250,000. If you made three tee shirts, it would go down. Four tee shirts, it would go down. So for a while, clearly the averaged cost gets smaller and smaller and smaller. Once you're making a lot of tee shirts, maybe half a million t-shirts, that cost of capital on average is just a dollar per t-shirt, it's no longer so important. Suddenly the cost of labor becomes important. And remember, the cost of labor also, at some point, starts to go up. So at some point, the extra cost of labor is going to be more important than the extra cost of capital. And it's going to start pulling up that average total cost. Let's think about this in another way as well.