Cost2 Final

7/29/2019 Cost2 Final

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Short Run Costs

Part 2


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The Costs of Production

There are many different types of costs.

Invariably, firms believe costs are too high

and try to lower them.


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Fixed Costs, Variable Costs,and Total Costs

Fixed costs are those that are spent andcannot be changed in the period of timeunder consideration.

In the long run there are no fixed costs since allcosts are variable.

In the short run, a number of costs will be fixed.


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Workers represent variable costs thosethat change as output changes.


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The sum of the variable and fixed costs aretotal costs.

TC = FC + VC


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Average Costs

Much of the firms discussion is of average

cost.


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Average Costs

Average fixed cost equals fixed cost dividedby quantity produced.

AFC = FC/Q


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Average Costs

Average variable cost equals variable costdivided by quantity produced.

AVC = VC/Q


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Average Costs

Average total cost can also be thought of asthe sum of average fixed cost and averagevariable cost.

ATC = AFC + AVC


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Average Total Costs

Average total cost (ATC):the per unit cost derived bydividing total cost by thequantity of output.

Plotting the cost on thevertical axis and quantity ofoutput on the horizontal axisgenerates the ATC curve. outputtotal

costtotalATC


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Fixed costs (FC)are those that are spent and cannot bechanged in the period of time under consideration

In the long run, there are no fixed costs since allinputs (and therefore their costs) are variable

In the short run, a number of inputs and their costswill be fixed

Workers are an example ofvariable costs (VC)which arecosts that change as output changes

The sum of the variable and fixed costs are total costs (TC)

TC = FC + VC

12-11


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Average fixed costs (AFC) equals fixed cost dividedby quantity produced,AFC = FC/Q

Marginal cost (MC)is the increase in total cost whenoutput increases by one unit, MC = TC/Q

Average variable costs (AVC) equals variable costdivided by quantity produced,AVC = VC/Q

Average total costs (ATC) equals total cost divided byquantity produced,ATC = TC/Q orATC = AFC + AVC

12-12


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Average Total Costs


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Marginal Cost

Marginal cost is the increase (decrease) intotal cost of increasing (or decreasing) thelevel of output by one unit.

In deciding how many units to produce, themost important variable is marginal cost.


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Marginal Costs

Marginal cost (MC): the change incost caused by a change in output,derived by dividing the change intotal cost by the change in the

quantity of output.

outputofquantityinchange

costin totalchangeMC


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The Cost of Producing Earrings

Output FC VC TC MC AFC AVC ATC

3 50 38 88 16.67 12.66 29.33

4 50 50 100 12 12.50 12.50 25.00

9 50 100 150 5.56 11.11 16.67

10 50 108 158 8 5.00 10.80 15.80

16 50 150 200 3.13 9.38 12.50

17 50 157 207 7 2.94 9.24 12.18

22 50 200 250

2.27 9.09 11.3623 50 210 260 10 2.17 9.13 11.30

27 50 255 305 1.85 9.44 11.30

28 50 270 320 15 1.79 9.64 11.42


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Graphing Cost Curves

To gain a greater understanding of theseconcepts, it is a good idea to draw a graph.

Quantity is put on the horizontal axis and adollar measure of various costs on thevertical axis.


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Total Cost Curves

The total variable cost curve has the sameshape as the total cost curveincreasingoutput increases variable cost.


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Totalcos

t

$400

350

300

250

200

150

10050

0

FC

2 4

M

6 8 10 20 30Quantity of earrings

VCTC

L

Total Cost Curves

O

TC = (VC + FC)


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Total Cost Curves

Totalco

st

$400

350

300

250

200

150

10050

0

FC

2 4

M

6 8 10 20 30

Quantity of earrings

VCTC

L

O

TC = VC + FC


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Average and Marginal CostCurves

The marginal cost curve goes through theminimum point of the average total cost curveand average variable cost curve.

Each of these curves is U-shaped.


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Average and Marginal CostCurves

The average fixed cost curve slopes downcontinuously.


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Downward-Sloping Shape ofthe Average Fixed Cost Curve

The average fixed cost curve looks like achilds slide it starts out with a steepdecline, then it becomes flatter and flatter.

It tells us that as output increases, the samefixed cost can be spread out over a widerrange of output.


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The U Shape of the Averageand Marginal Cost Curves

When output is increased in the short-run, itcan only be done by increasing the variableinput.


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The law of diminishing marginal productivitysets in as more and more of a variable inputis added to a fixed input.

Marginal and average productivities fall andmarginal costs rise.


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And when average productivity of the variableinput falls, average variable cost rise.


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The average total cost curve is the verticalsummation of the average fixed cost curveand the average variable cost curve.


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If the firm increased output enormously, theaverage variable cost curve and the averagetotal cost curve would almost meet.

The firms eye is focused on average total

costit wants to keep it low.


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Cost

$3028262422201816141210

8

642

0Quantity of earrings

2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32

Per Unit Output Cost Curves

AFC

AVCATCMC


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Per Unit Output Cost Curves

Cost

$3028262422201816141210

8

642

0

Quantity of earrings

2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32

AFC

AVCATCMC


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Relationship Between Marginal andAverage Costs

The marginal cost and average cost curvesare related.

When marginal cost exceeds average cost,

average cost must be rising.

When marginal cost is less than average cost,average cost must be falling.


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Average and Marginal Costs


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Relationship Between Marginaland Average Costs

Marginal cost curves always intersectaverage cost curves at the minimum of theaverage cost curve.


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The position of the marginal cost relative toaverage total cost tells us whether averagetotal cost is rising or falling.


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IfMC > ATC, then ATC is rising

IfMC > AVC, then AVC is rising

IfMC < ATC, then ATC is falling

IfMC < AVC, then AVC is falling

IfMC = AVC and MC = ATC, then AVCand ATC are at their minimum points

The Relationship BetweenMarginal Cost and Average Cost

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The Relationship BetweenMarginal Cost and Average Cost

AVC

MC

Q

Costsper unit

ATC The marginal cost curvegoes through theminimum point of both

the ATC and AVC curves

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To summarize:

If MC > ATC, then ATC is rising.

If MC = ATC, then ATC is at its low point.

If MC < ATC, then ATC is falling.


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Marginal and average total cost reflect ageneral relationship that also holds formarginal cost and average variable cost.

If MC > AVC, then AVC is rising.

If MC = AVC, then AVC is at its low point.

If MC < AVC, then AVC is falling.

R l i hi B M i l


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As long as average variable cost does notrise by more than average fixed cost falls,average total cost will fall when marginal cost

is above average variable cost,

R l i hi B M i l d


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Relationship Between Marginal andAverage Costs

$90

80

70

6050

4030

2010

0Quantity

Area B

Area A Area CMC

ATC

AVC

1 2 3 4 5 6 7 8 9

Q1

B

AVC

ATC

MCQ0A


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Definition of Costs

Total Costs (TC) -- the expenses a business

has in supplying goods and/or services. Total Fixed Costs (TFC) -- payments to

resources whose quantities can not be changedduring a fixed period of time the short run.

Total Variable Costs (TVC) -- payments foradditional resources used as output increases. Average Fixed Cost -- the total fixed cost

divided by total output.

Average total Cost (SRATC): -- the total cost ofproduction divided by the total quantity of outputproduced when at least one resource is fixed

Average Variable Cost -- total variable costdivided by total output

Cost2 Final

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