Short run
In the short run, a competitive firm’s supply curve is
a. its average variable cost curve to the right of the marginal cost curve.
b. its marginal cost curve above the average variable cost curve.
c. its marginal cost curves above its average total cost curve.
d. the horizontal summation of the marginal cost curves.
Cost is an important concept in both economics and accounting, but the definition of cost differs in the two
disciplines.
1. To an accountant, the cost of a resource is the actual cash outlay sexpended on it;
2. to an economist, the cost of a resource is the value of the resource in its next best alternative use.
That is, to an economist all costs are opportunity costs, which includeexplicit and implicit costs.
a. For a sole proprietorship an important implicit cost is the owner's time, which is equal
to the amount the owner could have earned working as an employee. For a corporation,
the key implicit cost is the opportunity cost of its capital.
8.2 Short-Run Cost of Production
The distinction between the long run and the short run in analyzing
1. production also applies to cost analysis. There are several measures of short run costs.
2. Total fixed cost (TFC) is the cost incurred by the firm that does not depend on how much output
it produces. For example, even if output is equal to zero, the firm still has to pay for its rent and
capital. Fixed costs are assumed to be equal to sunk costs.
3. Total variable cost (TVC) is the cost incurred by the firm that depends on how much output it
produces. For example, the more the firm produces, the more raw materials and labor it will
employ, which will lead to an increase its costs.
4. Total cost (TC) is the sum of total fixed and total variable cost at each output level.
5. Marginal cost (MC) is the change in total cost that results from a one-unit change in output.
6. Average fixed cost (AFC) is total fixed cost divided by the amount of output.
7. Average variable cost (AVC) is total variable cost divided by the amount of output.
8. Average total cost (ATC) is total cost divided by the output.
9. The firm's costs are determined by the production function and the prices of the inputs. Figure
8.1 in the text shows how the TP curve is transformed to the TVC curve simply by multiply the
variable input amount by the input price. Therefore, the slope of the TVC curve is determined
by the slope of the TP curve. Since the TP curve shows diminishing marginal returns, the
TVC curve shows diminishing returns as well.
8.3 Short-Run Cost Curves
10. Figure 8.3(a) in the text depicts some important relationships. First, the TFC curve is a
11. horizontal line. This is because TFC are constant and not a function of output. Second, the TC
12. curve is derived by summing the TFC and TVC curves. Notice how the TC curve has the same
13. slope as the TVC. However, since TC include TFC, the TC curve starts at the FC intercept.
14. Figure 8.3(b) shows the relationship between average and marginal costs. It is important to
15. understand how these curves relate to one another. First, the AFC curve is declining
16. throughout. Since FC are constant, increases in output lead to a decrease in AFC. Second, the
17. ATC and AVC curves are shaped like a wide U. The ATC curve will always lie above AVC
18. because ATC includes AFC. The minimum point on the AVC curve will always be slightly to
19. the left of the minimum point on the ATC curve. Third, the MC curve is shaped like a wide J,
20. which reflects the presence of diminishing marginal returns. In other words, when an input such
21. as labor is initially hired, output increases at an increasing rate implying per unit costs are
22. falling. However, at some point labor units increase output at a decreasing rate implying per
23. unit costs are increasing. In sum, the MC curve is determined by the shape of the Marginal
24. Product (MP) curve. When MP is increasing, MC is falling, and when MP is decreasing, MC is
25. rising. The MC curve will always intersect the minimum points on the ATC and AVC curves.
Short run
1. distinguish
a. three total cost curves
i. total fixed cost
ii. total variable cost
iii. total combined cost
Adding total fixed cost (TFC) of F0 to the TVC curve
yields the short run total cost curve.
The Shape of the TVC curve is determined by the
shape of the TP curve, which in turn reflects
diminishing marginal returns.
TFC-total fixed cost
Derived from total cost
1.
2.
3.
4.
1.
2.
3.
4.
5.
6.
7.
8.
Average total cost (ATC)
Average variable cost (AVC)
Average fixed cost (AFC)
Marginal Cost (MC)
Total fixed cost (TFC) is the cost incurred by the firm that does not depend on how much output it produces. For
example, even if output is equal to zero, the firm still has to pay for its rent and capital. Fixed costs are assumed to be
equal to sunk costs.
Total variable cost (TVC) is the cost incurred by the firm that depends on how much output it produces. For
example, the more the firm produces, the more raw materials and labor it will employ, which will lead to an increase
its costs.
Total cost (TC) is the sum of total fixed and total variable cost at each output level.
Marginal cost (MC) is the change in total cost that results from a one-unit change in output.
Average fixed cost (AFC) is total fixed cost divided by the amount of output.
Average variable cost (AVC) is total variable cost divided by the amount of output.
Average total cost (ATC) is total cost divided by the output.
The firm's costs are determined by the production function and the prices of the inputs.
Figure 8.1 in the text shows how the TP curve is transformed to the TVC curve simply by
multiply the variable input amount by the input price. Therefore, the slope of the TVC curve
is determined by the slope of the TP curve. Since the TP curve shows diminishing
marginal returns, the TVC curve shows diminishing returns as well.
Marginal cost having a U shape
1.
2.
3.
4.
5.
6.
Cost of additional units of output first falling, reaching a minimum and then rising.
Marginal cost falls first because the fixed plant and equipment are not designed to produce very low rates
of output, and production is very expensive when output is low.
At 4, decling marginal cost comes to end
Marginal cost rises with output. Eventually, marginal cost must rise because the plant will ultimately be
overutilized as output expand beyond the level it was designed.
This point MC begins to rise and each additional unit costs more than the last one
Shape comes from law of diminishing marginal returns.
a. MC-total change in variable cost that is associated with change in Q
b. MC-^TVC/^Q
Marginal Cost short run example
1.
2.
3.
4.
Law of Diminishing marginal returns
1.
2.
3.
4.
5.
6.
Marginal product of labor varies with amount of
output, therefore so does marginal cost.
Low level of output MPL=Rising, so Marginal
cost (w/MPL)=falling
MPL=MAX means MC=minimum
Minimum occurs at 4 units of output Rate of
output where marginal returns begins to fall
If MPL=declining then MC=rising
Example
a. 10 units output declined MPL=1/4
b. Therefore, one more unit requires 4
more units of labor at 10, so marginal
cost=40.
One unit increase means more Labor
More labor increases total variable cost
by ^Labor*Wage Rate
MC=^TVC/^q=w(L)/^q=w/mpl
Example
a. Output level at 4 units, w=10
and MPL=2/3 output
b. If 1 unit of labor increases
output by 2/3 MPL, then one
unit needs 3/2 units of labor at
a cost of 10 per unit.
c. Marginal cost at output level of
4 units is 15 or w/MPL=10/2/3
AVERAGE VARIABLE COST (AVC)
Average variable cost
1.
2.
3.
4.
1.
1.
2.
3.
4.
AVC= total variable cost/output
Very first unit of output, total variable cost,
average variable cost, marginal cot are all
equal
AVC=TVC/q=wL/Q=w/APL
a.
APL=q/L
Shape comes from law of diminishing marginal
returns
Shapes of per unit cost curves reflect the
underlying physical requirements of production.
Fewer units of the variable input are required per
unit of output.
a.
Average the AVC curve and for
marginal changes on the MC curve
b. Per unit costs fall. Conversely they rise
when input requirements per unit of
output increase
1 unit produce= all equal at 30
2 units=MC falls causing AVC to drop
AVC will decline as long as MC is below it
(1-4)
Per unit production tends to fall at low
prates of output but they go up like at 5
AVERAGE FIXED COST
1. AFC-declines over the entire data
range as the amount of total fixed
cost is spread over ever larger
rates of output
2. AFC CURVE- has an intriguing
property; if its height at any output
is multiplied by that output, the
area of the resulting rectangle
(height time width) is the same
regardless of the output level.
3. This happens because the ATC
curve show average total cost. It is
the sum of AFC and AVC and
measures average unit cost of all
inputs, both fixed and variable.
AVERAGE TOTAL COST (ATC)
1.
2.
3.
ATC=SUM AFC+AVC and measures average
unit cost of all inputs, both fixed and variable
Must also be U shaped although it minimum
point is located at a higher output than the
minimum point of AVC
This happens because
a.
ATC=AVC+AFC and at the output
where AVC is at a minimum, AFC is
still falling, so the sum of AVC and
AFC will continue to fall.
b. At somepoint, the rising AVC
offsets the falling AFC and
thereafter ATC rises.
c.
Finally because AVC+AFC=ATC, the
average fixed cost is the vertical
distance between ATC AND AVC.
d. This vertical distance becomes
smaller as more output is
produced, since AFC declines as
outputs rises
Marginal Average relationships
1. When marginal cost is below average (total or variable) cost, average cost will
decline.
a. When AVC is declining marginal cost must be below average cost.
i. Average cost=20 produce one more=15 average cost is falling
b. Marginal cost above average cost, average cost rises
i. AVC rising=MC rising
c. AVC=minimum, marginal cost is equal to average
i. Point where average cost is at a minimum the curve is essentially
flat over a small range of output.
ii. Curve is neither falling nor rising
iii. Small change in output does not change average cost
iv. If additional unit leaves AVC unchanged; MC=AVC
GEOMETRY OF COST CURVES
AVERAGE VARIABLE COST
Graph A=TOTAL VARIABLE COST CURVE
GRAPH B=AVERAGE VARIABLE COST AND MARGINAL COST CURVES
DERIVED FROM IT
1.
2.
3.
4.
5.
MARGINAL COST
1.
2.
Shown by slope of total variable cost curve at each rate of
output.
Example Q3
a.
Producing another unit of output=24$ indicated
by slope of TVC at point D in 8.3A
b. Height of marginal cost is 24$ in B.
c.
From origin, TVC curve becomes flatter as we
move up to point B,
i. Implying MC is falling until we get to
point B
ii. Beyond B it becomes steeper,
1. Indicating MC is rising
d. Point C
i. AVC=min, this means MC=AVC
Equals the slope of ray from the origin to a point on
the total variable cost curve.
Example
a.
Point A
i. AVC=slope of the ray 0A, or
21.67 per unit.
b. Q1
i. Ray 0A slope equal to Aq1/0q1
or 21.67 per unit or 65/3
MARGINAL COST MC
a.
The slope of the TVC curve at each point
b. Example
c.
Point D
i. Marginal cost is 24
Graph B
a.
Entire AVC and MC are shown
Ray
a.
Flatter ray from origin, the lower the AVC.
b. EXAMPLE
i. AVC min=20 when output=q2,
since ray 0C is the flattest ray
that touches the TVC CURVRE.
At point
ii. Thus AVC falls as output
increases from zero to q2 and
then rises at greater rates of
output
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