Alright guys, so like I said, now we're going to break up costs in a different way, right? Before, we were using explicit and implicit when we were going to calculate that profit, but now we are going to talk about costs as fixed costs or variable costs, okay? So fixed costs are costs that do not change as output changes. As we make more and more units, these fixed costs stay the same. They don't keep increasing as our output increases. Compare that to a variable cost, a variable cost is a cost that changes as output increases. Alright? And we're going to see some examples of that right now, but before we do that, I just want to say that when we talk about fixed costs, we're going to be using the acronym FC for fixed costs and for variable costs, VC for variable costs, right?
Total cost is going to be just the sum of fixed costs and variable costs, so it's just going to be fc+vc, right? Our total costs are going to be these fixed costs plus our variable costs. So let's go back to that idea of the Elon Musk case, right? He quit his job to start a bakery. So, what are going to be some of the fixed costs that Elon Musk Cakes is going to have? First, he's going to have the rent on the building, right? So if you think about the rent, let's say he pays $5,000 a month for his bakery, for the space where he has his bakery. Well, that $5,000 a month, it's not going to change based on how many cakes he makes, right? If he makes 1 cake or he makes 100 cakes, he's going to pay that same amount of rent regardless of how many cakes he makes that month, right? So that rent is a fixed cost, it's going to stay the same regardless of how many cakes he makes. Another one that's going to be a fixed cost is something like a bookkeeper's salary, right? If he hires a bookkeeper to take care of his business, that bookkeeper is going to make the same amount of money whether he's making 1 cake or he's making 100 cakes, right? That bookkeeper is going to make the same weekly salary regardless of what the output is of the company, right? So that salary is going to stay fixed regardless of output.
So let's consider some of the variable costs. Well, some of the variable costs are going to be those inputs that he puts directly into the cakes like sugar and flour, right? So sugar and flour are going to be some of our variable costs. You can imagine as he makes more and more cakes he’s going to need more sugar and more flour to make those cakes, right? So, it’s going to be things that are going up with the amount of output that you make, right? So things that increase with output. Another common one is day laborers, right? And we’re going to be dealing with this a little more, as we go on. So the idea of day laborers, right? As he makes more and more cakes, he’s going to need assistant chefs, right? So you would imagine that as he makes some cakes, he starts making some cakes he’s going to need an assistant. As he makes more and more cakes, he’s going to need more and more assistants helping him in the kitchen, right? So you'll see that these day laborers are variable cost, right? As he makes more and more cakes, he's going to need more and more of these day laborers to help him in the kitchen. Cool?
So that's the difference between these fixed costs and variable costs and now when we deal with these fixed costs and variable costs, most of the time we're going to be dealing with them as an average. The average fixed cost is going to be the fixed cost per unit. So to calculate an average cost all we need to do is just divide by the quantity, right? So we're going to have an amount of fixed costs and we're going to divide that by how many cakes we made, right? If there was that $5,000 fixed cost for the rent of the bakery, we can split that between how many cakes he made, right? How much of that fixed cost is it per cake? So we're going to have an average fixed cost which we're going to call AFC for 'average fixed cost', AVC for 'average variable cost', and very easy. Right? We're just going to have for fixed cost, it's going to be our fixed cost divided by quantity. For variable cost, it's going to be variable cost divided by quantity. And guess what? For total cost, well that's just going to be total cost divided by quantity. Right? But another way we could think about total cost, about our average total cost, is that we could just say that it's the average fixed cost plus the average variable cost. Either of those is also going to get us to our average total cost, right? Because up above, we define total cost as fixed cost plus variable cost. When we do a little bit of algebra, we'll see that this ends up being the same answer, right? So we can just take our total cost divided by quantity or if we have average fixed cost and average variable cost, we add those together to get average total cost. Cool?
One last thing to discuss, before we move on, we're going to be talking about two time periods in this class. There's going to be the short run and the long run. Okay? And there's not a very distinct definition of the short run; it's not 1 year, or 3 years, or 1 month. It’s going to be different for every business. The way we define the short run is the time period where at least one cost is fixed, okay? So if we have any fixed cost that means we’re in the short run, right? What could be something that is fixed? It could be the size of our factory, right? The factory size in the short run we’re basically stuck with this factory, right? We built a factory and we’re stuck with the constraint of this factory. We can only produce as much as this factory allows, right? So in the short run, that’s going to be fixed. Another thing that’s fixed is salaried employees, right? You might not be able to just fire these salaried employees in the short run, right? They’re going to be a fixed cost of the business.
So when we talk about the long run, compared to the short run, the long run is a time period where all costs become variable. So if you think in a long enough time period the size of the factory can be changed, right? If we think long enough maybe right now we’re stuck with this factory but eventually, we could demolish this factory, sell this factory, build a new one that’s bigger or build a new one that’s smaller, right? We can change the size of the factory. So, in the long run, the factory size ends up being variable, right? The amount we pay in rent becomes variable. Right now we might have a lease, that lease saying that we have to pay $5,000 a month for this bakery, but in the long run, that lease is going to expire, right? We don’t have that fixed cost anymore. We can reevaluate whether we want to have this current factory or want to build a new one. So we are going to be able to change the factory size in the long run, right? We can have that as variability, as a variable cost. Change factory size, and we'll be able to fire salaried employees. Right? If you in the long run, we’re going to be able to reevaluate everything about our business, we can fire people, we can change our factory size, we can take all those fixed costs and they'll be variable costs in the long run. Okay? So that's how we define time periods, right? It’s not a distinct amount of time, each business is going to have a different short run and a long run. It just depends on how long it takes you, to be able to treat your costs as variable costs, alright? So that's it, let's go ahead and move on to the next video.