Three Types of Costs
There are three types of costs:
Average cost per unit.
Marginal cost per unit.
All the following explanations about three types of costs relate to the production possibilities curve of Country A.
Moving from Point B to Point C adds 300 guns by sacrificing 600 loaves of bread (1,000 - 400 = 600). The total cost of this transaction (Transaction A) is 600 loaves of bread.
Moving from Point C to Point D adds 100 more guns by sacrificing 400 loaves of bread (400 - 0 = 400). The total cost of this transaction (Transaction B) is 400 loaves of bread.
Average Cost Per Unit
In Transaction A, one gun costs two loaves of bread (600/ 300 = 2) on the average.
In Transaction B, one gun costs four loaves of bread (400/ 100 = 4) on the average. If a loaf of bread costs $1, then the average cost per gun would be $2 in Transaction A, and $4 in Transaction B.
To understand the meaning of opportunity cost, imagine that the product being sacrificed equals one dollar, and then replace the word dollar with gun or bread, whichever is relevant.
The Marginal Price of Bread
When bread is baked, the cost of the last loaf baked is called the marginal cost. Every point on the PPC can be regarded as a quantity of bread. At Point B, 1,000 loaves of bread are baked. The marginal cost of bread at point B means the cost of baking the one-thousandth loaf of bread.
The marginal cost at Point C is the cost of making the four-hundredth loaf of bread.