Monday, July 14, 2008
FAQ On Costings (Unit 4)
Theory of costing
Popular FAQ by students:
1. Why the average fixed costs (AFC) curve looks like a hyperbola?
AFC = (TFC/ Q). It looks like a hyperbola because fixed cost is spread over a larger range of output e.g. 50/5, 50/8, 50/10 etc (yellow line)
2. Why marginal cost (MC) curve looks like a ‘Nike’ sign?
We have to relate this one to the theory of marginal productivity of labour. By hiring an optimal number of labours, works can be done efficiently. As productivity increase, MC will initially fall. However, if more & more labours are being hired, overall productivity will be affected & this means increase in the costs of production. This explains why at a later part the MC will increase (green line)
Think about this. What will happen if you put 10 employees in a small office with maximum capacity of 5 employees?
3. What does the gap between AC & AVC means?
The gap means AFC since AFC = AC—AVC
4. Why is the gap between AC & AVC getting smaller towards the end?
Again the gap means AFC. Smaller gap towards the end means falling value of AFC as fixed cost is largely spread over a greater range of output