A2 Economics Mr. Durham durham.j@shishialevel.cn http://durham-a2econ.wikispaces.com

Lesson Objectives Students should be able to Illustrate the TC, TVC, and TFC curves, and Discuss describe the reason behind the shapes Explain the shape of the ATC curve and the MC curve

Todays Plan Fixed & Variable Costs The Average Cost Curves Review & Shape of Curves The Average Cost Curves ATC, AVC, & AFC

Fixed and Variable Costs Fixed Cost: a short-run cost that of production that does not change as the quantity of output changes Variable Cost: a short-run cost of production that changes as output changes.

Movie Time Variable & Fixed Costs

Review FC and VC Jay set up his hot dog stand near the business district. His total variable cost includes the _______. annual insurance for the hot dog stand cost of buying the hot dog stand cost of the hot dogs and condiments interest he pays on the funds he borrowed to pay for advertising revenue he gets when he sells his first hot dog each day Answer: C

Review FC and VC Jay set up his hot dog stand near the business district. His total variable cost includes the _______. annual insurance for the hot dog stand cost of buying the hot dog stand cost of the hot dogs and condiments interest he pays on the funds he borrowed to pay for advertising revenue he gets when he sells his first hot dog each day Answer: C

Activity Given: What you know about Fixed and Variable Costs – (by definition) Illustrate the following: TFC Curve TVC Curve TC Curve

SHORT-RUN COST Total fixed cost (TFC) is constant—it graphs as a horizontal line. Total variable cost (TVC) increases as output increases. Total cost (TC) also increases as output increases.

Drawing Activity Explain: The shape of the cost curves and the distance between the TC and TVC

SHORT-RUN COST The vertical distance between the total cost curve and the total variable cost curve is total fixed cost, as illustrated by the two arrows.

SR Costs Total variable cost (TVC) is the cost of the variable factor of production used by a firm—the cost of labor. To change its output in the short run, a firm must change the quantity of labor it employs, so total variable cost changes as output changes. Total cost is the sum of total fixed cost and total variable cost. That is, TC = TFC + TVC Table 14.2 on the next slide shows Sam’s Smoothies’ costs.

14.3 SHORT-RUN COST

SHORT-RUN COST Recall: The MP Curve is the shape of an upside down Nike symbol. Can that help explain the rate of change in the Variable Cost. Take a Minute: Form a description of the relationship between MP and the shape of the TVC Curve

Weekend Homework HW: Handout on Production and Costs Review of Weekend HW

MC, ATC, AVC Moving on to Marginal Cost and Average Cost Curves Point: These are the cost curves to a firm that are used to find the profit maximizing quantity and price. Meaning these are important to us

SHORT-RUN COST Marginal Cost A firm’s marginal cost is the change in total cost that results from a one-unit increase in total product. Marginal cost tells us how total cost changes as total product changes. Table on the next slide calculates marginal cost for Sam’s Smoothies.

SHORT-RUN COST Average Cost There are three average cost concepts: Average fixed cost (AFC) is total fixed cost per unit of output. Average variable cost (AVC) is total variable cost per unit of output. Average total cost (ATC) is total cost per unit of output.

SHORT-RUN COST The average cost concepts are calculated from the total cost concepts as follows: TC = TFC + TVC Divide each total cost term by the quantity produced, Q, to give Q Q Q TC = TFC + TVC or, ATC = AFC + AVC

SHORT-RUN COST Average fixed cost (AFC) decreases as output increases. The average variable cost curve (AVC) is U-shaped. The average total cost curve (ATC) is also U-shaped.

SHORT-RUN COST Question: What is the vertical distance indicated by the arrows in this diagram?

SHORT-RUN COST The vertical distance between ATC and AVC curves is equal to AFC, as illustrated by the two arrows. Note: The marginal cost curve (MC) is U-shaped and intersects the average variable cost curve and the average total cost curve at their minimum points.

Question Why is the ATC curve U-Shaped? Tip: Recall that ATC is made up of 2 parts, the AVC and the AFC. They have two opposite effects

SHORT-RUN COST Why the Average Total Cost Curve Is U-Shaped Point1: Average total cost, ATC, is the sum of average fixed cost, AFC, and average variable cost, AVC. Point 2: The shape of the ATC curve combines the shapes of the AFC and AVC curves. Point3: The U shape of the average total cost curve arises from the influence of two opposing forces: Spreading total fixed cost over a larger output Decreasing marginal returns

Module Firm Costs ATC AFC AVC AFC falls as quantity produced increases Because the TFC is spread out among more units “the spreading effect” AVC increases as quantity produced increases Because of diminishing returns from the variable input “the diminishing returns effect” Apply the 2 Effects to the U-Shaped ATC:

U Shaped ATC Curve Divide the ATC into 2 Parts: Downward Sloping and Upward Sloping Part 1: The Spreading Effect outweighs the Diminishing Returns Effect Part 2: The Diminishing Returns Effect outweighs the Spreading Effect

Module Firm Costs

Review - Firm Costs Key Relationships When MP is at its peak, then MC must be at its minimum MC is the mirror image of MP If MP is rising: them MC is _________ If MP is falling: then MC is _________ When AP is rising: AVC is __________ When AP is falling: AVC is __________ When TP is increasing at an increasing rate, the TC is _______ at a ___________ rate When TP is increasing at a decreasing rate, the TC is _________ at an __________ rate

Review - Firm Costs Key Relationships When MP is at its peak, then MC must be at its minimum MC is the mirror image of MP If MP is rising: them MC is falling If MP is falling: then MC is rising When AP is rising: AVC is falling When AP is falling: AVC is rising When TP is increasing at an increasing rate, the TC is increasing at a decreasing rate When TP is increasing at a decreasing rate, the TC is increasing at an increasing rate

Homework HW: Handout on MC and ATC