In practice, developing that cost information requires considerable work. We assume that this work has been done.

Total Cost: is what it costs to operate at some particular rate of output.

Total Cost is NOT the cost per item. That's the Average Cost, which we'll discuss in another tutorial.

Total cost can be divided into two portions: Fixed Cost and Variable Cost.

Fixed Cost: Fixed Cost is the part of the budget that stays the same regardless of whether you produce a lot, a little bit, or even if you produce zero. Overhead, rent on buildings, and interest on loans are in fixed cost.

Variable Cost: is the rest of Total Cost, the part that varies as you produce more or less. Producing more adds to Variable Cost. Producing less reduces it.

Which costs are fixed and which costs are variable depends on your time horizon.

In what economists call the "short run," labor cost (staffing) might be fixed. A lab may have a certain number of technicians, for example. From day to day, its cost for materials might vary, depending on how many tests it does, but the labor cost is fixed. 

In the "longer run," labor costs might be variable, as the lab adjusts staffing to the demand for its tests, but costs for its facility (space and major equipment) would be fixed. 

In the "long run," the lab can change its space and equipment. No costs would be fixed in the long run.

For Joan's, we'll imagine an intermediate run, where labor and materials are variable costs, but overhead is not. (The cost numbers in the following tables are made up for illustrative purpose. They are not represented as realistic.)

Marginal Cost: Now let's introduce marginal cost. Marginal cost is the difference in total cost between one rate of output and another. Usually, unless stated otherwise, the marginal cost is the change in cost that results from changing the output by one unit.

Here's the top part of the cost table, with a column added for Marginal Cost. I've left spaces between the lines for the marginal costs. This emphasizes that marginal cost is the difference in total cost between one output rate and another.

Just do a mental calculation for the values of Marginal Cost in the shaded boxes in the table below (& check your answers in this table):

Check your answers in this table:

Interlude on the Law of Diminishing Returns:

So far, the marginal cost has been falling as output has been rising. The fourth patient added in a year costs Joan's much less than the first patient. Does this illustrate the Law of Diminishing Returns?

Answer in “Yes” or “No”…….

If your answer is “No”, you are Correct!  - Marginal cost is falling, not rising.  The return from more effort is increasing.

If your answer is “Yes”, you are Wrong!  - Marginal cost is falling, not rising.  The return from more effort is not diminishing.

The Law of Diminishing Returns is an economics classic. It says: As you repeat doing something, each repetition becomes harder and/or less rewarding. The "returns" to your extra efforts "diminish". In our context here, diminishing returns would mean that marginal cost increases as Joan's adds more patients in a year. That's the opposite of what we have so far. So far, the "Law" of Diminishing Returns doesn't apply to Joan's. Instead, we have increasing returns.

Things change, though, in the next part of the cost table:

Just do a mental calculation for the values of Marginal Cost in the shaded boxes in the table below (& check your answers in this table):

Second Interlude on the Law of Diminishing Returns:

The seventh patient in a year adds more to Joan's costs than the fourth one did. Does this illustrate the Law of Diminishing Returns?

Answer in “Yes” or “No”…….

If your answer is “Yes”, you are Correct!  - We had increasing returns at first.

This means that marginal cost equals marginal variable cost. For example, suppose part of Joan's fixed cost is the cost of an advertisement in the Yellow Pages. That cost doesn't change when her company adds one more patient.

Here's the table with all the Variable and Marginal Costs:

Here are those cost data in a graph.