Unit 3: Costs of Production and Perfect Competition Copyright ACDC Leadership 2015

Short-Run Production Costs Copyright ACDC Leadership 2015

Definition of the “Short-Run” We will look at both short-run and long-run production costs. Short-run is NOT a set specific amount of time. The short-run is a period in which at least one resource is fixed. Plant capacity/size is NOT changeable In the long-run ALL resources are variable NO fixed resources Plant capacity/size is changeable Today we will examine short-run costs 3 Copyright ACDC Leadership 2015

Different Economic Costs Total Costs FC = Total Fixed Costs VC = Total Variable Costs TC = Total Costs Per Unit Costs AFC = Average Fixed Costs AVC = Average Variable Costs ATC = Average Total Costs MC = Marginal Cost Copyright ACDC Leadership 2015

Definitions Fixed Costs: Variable Costs: Costs for fixed resources that DON’T change with the amount produced Ex: Rent, Insurance, Managers Salaries, etc. Average Fixed Costs = Fixed Costs Quantity Variable Costs: Costs for variable resources that DO change as more or less is produced Ex: Raw Materials, Labor, Electricity, etc. Average Variable Costs = Variable Costs Quantity Copyright ACDC Leadership 2015

Definitions Total Cost: Marginal Cost: Sum of Fixed and Variable Costs Average Total Cost = Total Costs Quantity Marginal Cost: Additional costs of an additional output. Ex: If the production of two more output increases total cost from $100 to $120, the MC is _____. $10 Marginal Cost = Change in Total Costs Change in Quantity Copyright ACDC Leadership 2015

Calculating Costs Notice that the AVC + AFC = ATC ATC of 6 Units Fill out the chart then calculate: ATC of 6 Units AFC of 2 Units AVC of 4 Units ATC of 1 Unit AVC of 5 Units AFC of 5 Units ATC of 5 Units Output Variable Cost Fixed Total Marginal $0 $10 - 1 2 $17 3 $25 4 $40 5 $60 6 $110 $10 $10 $20 $27 $35 $50 $70 $120 - $10 $7 $8 $15 $20 $50 $20 $5 $10 $12 $2 $14 Notice that the AVC + AFC = ATC For 5 Units: AVC ($12) + AFC ($2) = ATC ($14) Is this is true for 4 Units? Copyright ACDC Leadership 2015

Notice that the AVC + AFC = ATC Calculating Costs Output Variable Cost Fixed Total Marginal $0 $10 - 1 $20 2 $17 $27 $7 3 $25 $35 $8 4 $40 $50 $15 5 $60 $70 6 $110 $120 AVC AFC ATC - $10 $20 $8.50 $5 $13.50 $8.33 $3.33 $11.66 $2.50 $12.50 $12 $2 $14 $18.33 $1.67 $20 $5 $10 $12 $2 $14 Notice that the AVC + AFC = ATC Copyright ACDC Leadership 2015

Calculating Costs AVC AFC ATC - $10 $20 $8.50 $5 $13.50 $8.33 $3.33 $11.66 $2.50 $12.50 $12 $2 $14 $18.33 $1.67 $20 $5 $10 $12 $2 $14 Copyright ACDC Leadership 2015

ATC and AVC get closer and closer but NEVER touch MC Costs ATC $20 $18 $16 $14 $12 $10 $8 $6 $4 $2 AVC ATC and AVC get closer and closer but NEVER touch Average Fixed Cost AFC 1 2 3 4 5 6 Quantity Copyright ACDC Leadership 2015

Calculate TC, VC, and FC of the 5th Unit MC Costs ATC $20 $18 $16 $14 $12 $10 $8 $6 $4 $2 AVC Calculate TC, VC, and FC of the 5th Unit TC= $70 VC= $60 TC = $10 AFC 1 2 3 4 5 6 Quantity Copyright ACDC Leadership 2015

Total Cost Curves TC FC + VC = TC VC $10 FC Fixed Cost Costs Quantity Copyright ACDC Leadership 2015

Practice 13

2008 Audit Exam 50. c Copyright ACDC Leadership 2015

1. A C 2.

7.D

Calculating Costs Practice Fill out the chart then calculate: ATC of 6 Units AFC of 2 Units AVC of 3 Units ATC of 5 Units AVC of 2 Units AVC of 4 Units AFC of 4 Units ATC of 4 Units Output Variable Cost Fixed Total Marginal $0 $20 - 1 $12 2 $22 3 $27 4 $40 5 $60 6 $100 $20 $10 $9 $16 $11 $5 Copyright ACDC Leadership 2015

How much does the 10th unit costs? MC $30 25 20 15 10 5 ATC AVC Calculate TC, VC, and FC Total Cost=$200 Variable Cost=$150 Fixed Cost=$50 Notice that VC + FC = TC AFC 7 8 9 10 11 Quantity Copyright ACDC Leadership 2015

Per-Unit Costs (Average and Marginal) At output Q, what area represents: TC VC FC 0CDQ 0BEQ 0AFQ or BCDE Copyright ACDC Leadership 2015

More Practice 20

Additional Practice TP VC FC TC MC AVC AFC ATC 100 1 10 2 16 3 21 4 26 100 1 10 2 16 3 21 4 26 5 30 6 36 7 46 Copyright ACDC Leadership 2015

Calculating TC, VC, FC, ATC, AFC, and MC TP VC FC TC MC AVC AFC ATC 100 1 10 2 16 3 21 4 26 5 30 6 36 7 46 Copyright ACDC Leadership 2015

Calculating TC, VC, FC, ATC, AFC, and MC TP VC FC TC MC AVC AFC ATC 100 1 10 110 2 16 116 3 21 121 4 26 126 5 30 130 6 36 136 7 46 146 Copyright ACDC Leadership 2015

Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 3 21 100 - 1 10 110 2 16 116 3 21 121 4 26 126 5 30 130 6 36 136 7 46 146 Copyright ACDC Leadership 2015

Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 3 100 - 1 10 110 2 16 116 6 3 21 121 5 4 26 126 30 130 36 136 7 46 146 Copyright ACDC Leadership 2015

Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 100 - 1 10 110 2 16 116 6 8 3 21 121 5 7 4 26 126 6.5 30 130 36 136 46 146 6.6 Copyright ACDC Leadership 2015

Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 100 - 1 10 110 2 16 116 6 8 50 3 21 121 5 7 33.3 4 26 126 6.5 25 30 130 20 36 136 16.67 46 146 6.6 14.3 Asymptote Copyright ACDC Leadership 2015

Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 40.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Per Unit Costs TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 40.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Calculate A-E TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 A 100 - 1 10 110 2 16 116 6 8 A 58 3 21 121 5 B 33.3 40.3 4 26 126 6.5 25 31.5 30 130 D E 36 136 C 16.67 22.67 7 46 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Calculating TC, VC, FC, ATC, AFC, and MC TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 40.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Calculating TC, VC, FC, ATC, AFC, and MC TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 40.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Marshmallow Towers Activity Copyright ACDC Leadership 2015

Shapes of Cost Curves Copyright ACDC Leadership 2015

Why does marginal cost always go down then up? MC Costs Quantity Copyright ACDC Leadership 2015

MP and MC are mirror images of each other Relationship between Production and Cost Output As more workers are hired, their marginal product increases and then eventually decreases because of the law of diminishing marginal returns MP The additional costs (MC) of the units they produce fall when MP goes up, but eventually increase as additional workers produce less and less output MP and MC are mirror images of each other Quantity of labor Costs MC Quantity of output Copyright ACDC Leadership 2015

Why is the MC curve U-shaped? The MC curve falls and then rises because of diminishing marginal returns. Example: Assume the fixed cost is $20 and the ONLY variable cost is the cost for each worker (Wage = $10) Workers Total Prod Marg Prod Total Cost Marginal Cost 1 5 2 13 3 19 4 23 25 6 26 Copyright ACDC Leadership 2015

Why is the MC curve U-shaped? The MC curve falls and then rises because of diminishing marginal returns. Example: Assume the fixed cost is $20 and the ONLY variable cost is the cost for each worker (Wage = $10) Workers Total Prod Marg Prod Total Cost Marginal Cost - 1 5 2 13 8 3 19 6 4 23 25 26 Copyright ACDC Leadership 2015

Why is the MC curve U-shaped? The MC curve falls and then rises because of diminishing marginal returns. Example: Assume the fixed cost is $20 and the ONLY variable cost is the cost for each worker (Wage = $10) Workers Total Prod Marg Prod Total Cost Marginal Cost - $20 1 5 $30 2 13 8 $40 3 19 6 $50 4 23 $60 25 $70 26 $80 Copyright ACDC Leadership 2015

Why is the MC curve U-shaped? The MC curve falls and then rises because of diminishing marginal returns. Example: Assume the fixed cost is $20 and the ONLY variable cost is the cost for each worker (Wage = $10) Workers Total Prod Marg Prod Total Cost Marginal Cost - $20 1 5 $30 10/5 = $2 2 13 8 $40 10/8 = $1.25 3 19 6 $50 10/6 = $1.6 4 23 $60 10/4 = $2.5 25 $70 10/2 = $5 26 $80 10/1 = $10 Copyright ACDC Leadership 2015

Why is the MC curve U-shaped? The additional cost of the first 13 units produced falls because workers have increasing marginal returns. As production continues, each worker adds less and less to production so the marginal cost for each unit increases. Workers Total Prod Marg Prod Total Cost Marginal Cost - $20 1 5 $30 10/5 = $2 2 13 8 $40 10/8 = $1.25 3 19 6 $50 10/6 = $1.6 4 23 $60 10/4 = $2.5 25 $70 10/2 = $5 26 $80 10/1 = $10 Copyright ACDC Leadership 2015

Relationship between Production and Cost Why does ATC go down then up? When the marginal cost is below the average, it pulls the average down. When the marginal cost is above the average, it pulls the average up. Costs MC ATC Quantity MC intersects the ATC curve at ATC’s lowest point Example: The average income in the room is $50,000. An additional (marginal) person enters the room: Bill Gates. If the marginal is greater than the average it pulls it up. Notice that MC can increase but still pull down the average. Copyright ACDC Leadership 2015

2008 Audit Question 23 23. C Copyright ACDC Leadership 2015

2010 Question 18 B Copyright ACDC Leadership 2015

When in doubt, graph it out MC Costs ATC $12 $10 $8 $2 AVC AFC 100 Quantity Copyright ACDC Leadership 2015

1. 2. E D

Shifting Cost Curves Copyright ACDC Leadership 2015

What if Fixed Costs increase to $200 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 30.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 What if Fixed Costs increase to $200 Copyright ACDC Leadership 2015

Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 30.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 200 100 - 1 10 110 2 200 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 30.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Which Per Unit Cost Curves Change? Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 200 - 1 10 210 100 110 2 16 216 6 8 50 58 3 21 221 5 7 33.3 30.3 4 26 226 6.5 25 31.5 30 230 20 36 236 16.67 22.67 46 246 6.6 14.3 20.9 Which Per Unit Cost Curves Change? Copyright ACDC Leadership 2015

ONLY AFC and ATC Increase! Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 200 - 1 10 210 100 110 2 16 216 6 8 50 58 3 21 221 5 7 33.3 30.3 4 26 226 6.5 25 31.5 30 230 20 36 236 16.67 22.67 46 246 6.6 14.3 20.9 ONLY AFC and ATC Increase! Copyright ACDC Leadership 2015

ONLY AFC and ATC Increase! Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 200 - 1 10 210 110 2 16 216 6 8 100 58 3 21 221 5 7 66.6 30.3 4 26 226 6.5 50 31.5 30 230 40 36 236 33.3 22.67 46 246 6.6 28.6 20.9 ONLY AFC and ATC Increase! Copyright ACDC Leadership 2015

If fixed costs change ONLY AFC and ATC Change! Shifting Costs Curves If fixed costs change ONLY AFC and ATC Change! TP VC FC TC MC AVC AFC ATC 200 - 1 10 210 2 16 216 6 8 100 108 3 21 221 5 7 66.6 73.6 4 26 226 6.5 50 56.5 30 230 40 46 36 236 33.3 39.3 246 6.6 28.6 35.2 MC and AVC DON’T change! Copyright ACDC Leadership 2015

Shift from an increase in a Fixed Cost MC ATC1 ATC AVC Costs (dollars) AFC1 AFC Quantity Copyright ACDC Leadership 2015

Shift from an increase in a Fixed Cost MC ATC1 AVC Costs (dollars) AFC1 Quantity Copyright ACDC Leadership 2015

What if the cost for variable resources increase Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 30.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 What if the cost for variable resources increase Copyright ACDC Leadership 2015

Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 10 110 2 16 100 - 1 10 110 2 16 116 6 8 50 58 3 21 121 5 7 33.3 30.3 4 26 126 6.5 25 31.5 30 130 20 36 136 16.67 22.67 46 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 11 110 10 2 100 - 1 11 110 10 2 18 116 6 8 50 58 3 24 121 5 7 33.3 30.3 4 30 126 6.5 25 31.5 35 130 20 26 43 136 16.67 22.67 55 146 6.6 14.3 20.9 Copyright ACDC Leadership 2015

Which Per Unit Cost Curves Change? Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 11 111 10 110 2 18 118 6 8 50 58 3 24 124 5 7 33.3 30.3 4 30 130 6.5 25 31.5 35 135 20 26 43 143 16.67 22.67 55 155 6.6 14.3 20.9 Which Per Unit Cost Curves Change? Copyright ACDC Leadership 2015

Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 11 111 10 110 100 - 1 11 111 10 110 2 18 118 7 8 50 58 3 24 124 6 33.3 30.3 4 30 130 6.5 25 31.5 5 35 135 20 26 43 143 16.67 22.67 55 155 12 6.6 14.3 20.9 MC, AVC, and ATC Change! Copyright ACDC Leadership 2015

Shifting Costs Curves TP VC FC TC MC AVC AFC ATC 100 - 1 11 111 110 2 100 - 1 11 111 110 2 18 118 7 9 50 58 3 24 124 6 8 33.3 30.3 4 30 130 7.5 25 31.5 5 35 135 20 26 43 143 7.16 16.67 22.67 55 155 12 7.8 14.3 20.9 MC, AVC, and ATC Change! Copyright ACDC Leadership 2015

If variable costs change MC, AVC, and ATC Change! Shifting Costs Curves If variable costs change MC, AVC, and ATC Change! TP VC FC TC MC AVC AFC ATC 100 - 1 11 111 2 18 118 7 9 50 59 3 24 124 6 8 33.3 41.3 4 30 130 7.5 25 32.5 5 35 135 20 27 43 143 7.16 16.67 23.83 55 155 12 7.8 14.3 22.1 Copyright ACDC Leadership 2015

Shift from an increase in a Variable Costs MC1 MC ATC1 AVC1 ATC AVC Costs (dollars) AFC Quantity Copyright ACDC Leadership 2015

Shift from an increase in a Variable Costs MC1 ATC1 AVC1 Costs (dollars) AFC Quantity Copyright ACDC Leadership 2015