This video explains how different types of costs affect the production process. We start by explaining the main characteristics of fixed and variable costs, and how these form total cost. Finally, we explain its relationship with returns to scale.
When analysing costs, the first thing to know is that there are fixed and variable costs:
Fixed costs: fixed costs cannot be altered in short run. They mainly include things like rent, repayments on technology, etc., which require time to change, and are often associated with indirect production costs (all that which is not a direct input). They do not depend on the level of production and cannot be adjusted accordingly.
Variable costs: variable costs depend on the level of production, and can include things such as direct inputs (raw materials) and contracted labour hours (not fixed salaries).
The way in which fixed and variable costs affect production is related with returns to scale. The video shows three phases. In phase I, where the elasticity of scale is greater than 1, there are increasing returns to scale, while phase III corresponds to decreasing returns to scale. In point II, the elasticity of scale equals 1, which represents constant returns to scale.
Learn more by reading the dictionary entry.