What Cost Look Like & How They Determine How Much a Firm Will Supply Costs of Production What Cost Look Like & How They Determine How Much a Firm Will Supply

3 The Total-Cost curve Total Cost 5.00 4.00 3.00 2.00 1.00 8.00 7.00 6.00 9.00 10.00 11.00 12.00 13.00 14.00 $15.00 Total-cost curve Quantity of Output (cups of coffee per hour) 1 2 3 4 5 6 7 8 9 10 Here the quantity of output produced (on the horizontal axis) is from the first column in Table 2, and the total cost (on the vertical axis) is from the second column. As in Figure 2, the total-cost curve gets steeper as the quantity of output increases because of diminishing marginal product.

The Various Measures of Cost Fixed costs (short-run) (capital, e.g., rent/leased space) Do not vary with the quantity of output produced Variable costs (short and long-run) (e.g. labor and materials) Vary with the quantity of output produced Average fixed cost (AFC) – decline throughout Fixed cost divided by the quantity of output Average variable cost (AVC) – “U-shaped” Variable cost divided by the quantity of output

The Various Measures of Cost Average total cost = Total Costs(Q) ÷Q Cost of a typical unit of output Average Fixed Costs = Total Fixed Costs ÷ Q ATC = TC / Q Average Variable Costs = Total Var Costs ÷ Q AVC = TVC/Q Marginal cost = ΔTC(Q+1 – Q)/ΔQ or MC = ΔTC / ΔQ Change in total cost from producing an 1 more unit of output

EXHIBIT 5.3 The Cost Curves 5-5

The Various Measures of Cost Cost curves and their shapes U-shaped average total cost: ATC = AVC + AFC AFC – always declines as output rises AVC – typically rises as output increases Diminishing marginal product At the minimum of ATC or AVC The bottom (lowest point) of the U-shaped curve MC = min(ATC) and MC = min(AVC)

 FIGURE 9.2 Short-Run Supply Curve of a Perfectly Competitive Firm At prices below average variable cost, it pays a firm to shut down rather than continue operating. Thus, the short-run supply curve of a competitive firm is the part of its marginal cost curve that lies above its average variable cost curve.

The Various Measures of Cost Cost curves and their shapes Efficient scale Quantity of output that minimizes average total cost Relationship between MC and ATC When MC < ATC: average total cost is falling When MC > ATC: average total cost is rising The marginal-cost curve crosses the average-total-cost curve at its minimum

Average total cost in the short and long runs 6 Average total cost in the short and long runs Average Total Cost ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory ATC in long run Economies of scale Diseconomies of scale $12,000 1,200 10,000 Constant returns to scale 1,000 Quantity of Cars per Day Because fixed costs are variable in the long run, the average-total-cost curve in the short run differs from the average-total-cost curve in the long run.

Costs in Short Run and in Long Run Many decisions Some inputs are fixed(unalterable), like Kapital in the short run All inputs are variable in the long run, Firms – greater flexibility in the long-run Long-run cost curves Differ from short-run cost curves Much flatter than short-run cost curves Short-run cost curves – e.g., different sized factories (or Kapital) Lie on or above the long-run cost curves