Copyright 2002, Pearson Education Canada1 Short-Run Costs and Output Decisions Chapter 8

Copyright 2002, Pearson Education Canada2 Costs in the Short Run zA fixed cost is any cost that a firm bears in the short run that does not depend on its level of output. These costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run. zA variable cost is any cost that a firm bears that depends on the level of production chosen.

Copyright 2002, Pearson Education Canada3 Total Costs (TC) zTotal Costs = Total + Total Fixed Costs Variable Costs zTC = TFC + TVC

Copyright 2002, Pearson Education Canada4 AFC = Total Fixed Costs quantity of output Average Fixed Costs zAverage fixed cost (AFC) is the total fixed costs divided by the number of units of output; a per unit measure of fixed costs. zSpreading overhead is the process of dividing total fixed costs by more units of output. Average fixed costs decline as output rises.

Copyright 2002, Pearson Education Canada5 Short Run Fixed Cost (Total and Average) of a Hypothetical Firm (Figure 8.2)

Copyright 2002, Pearson Education Canada6 Total Variable Cost Curve (Figure 8.3) zThe total variable cost curve is a graph that shows the relationship between total variable cost and the level of a firm’s output. zIt shows the cost of production using the best available technique at each output level, given current factor prices.

Copyright 2002, Pearson Education Canada7 Marginal Costs (MC) zMarginal cost is the increase in total cost that results from producing one more unit of output. zMarginal costs reflect changes in variable costs. zIn the short run, every firm is constrained by some fixed input that leads to diminishing returns to variable inputs and that limits its capacity to produce. As the firm approaches capacity, it becomes increasingly costly to produce more output. Marginal costs ultimately increase with output in the short run.

Copyright 2002, Pearson Education Canada8 Declining Marginal Product Implies That Marginal Cost Will Eventually Rise With Output (Figure 8.4)

Copyright 2002, Pearson Education Canada9 Marginal Cost and Total Variable Cost zSlope of TVC = ΔTVC = ΔTVC = ΔTVC = MC Δq 1

Copyright 2002, Pearson Education Canada10 Total Variable Cost and Marginal Cost for a Typical Firm (Figure 8.5) zIn the short run, every firm is constrained by some fixed factor of production. Having a fixed input implies diminishing returns (declining marginal product) and a limited capacity to produce. As that limit is approached marginal costs rise.

Copyright 2002, Pearson Education Canada11 Average Variable Costs zAverage variable cost (AVC) is total variable cost divided by the number of units of output. zAVC = TVC q zAverage variable cost always moves toward marginal cost.

Copyright 2002, Pearson Education Canada12 Relationship Between Marginal Cost and Average Variable Cost (Figure 8.6) zRising marginal cost intersects average variable cost at the minimum point of AVC.

Copyright 2002, Pearson Education Canada13 Total Costs zTC = TFC + TVC zAverage total cost is the total cost divided by the number of units of output. zATC = TC q

Copyright 2002, Pearson Education Canada14 Average Total Cost = Average Variable Cost + Average Fixed Cost (Figure 8.8) zMarginal cost crosses both AVC and ATC at their minimum values. zAVC and ATC get closer together as output increases since AFC falls as output rises, but they never cross.

Copyright 2002, Pearson Education Canada15 Total and Marginal Revenue zTotal revenue is the total amount that a firm takes in from the sale of its product: The price per unit times the quantity of output the firm decides to produce (P x q). zMarginal revenue is the additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition, P = MR.

Copyright 2002, Pearson Education Canada16 Comparing Costs and Revenues to Maximize Profit zAs long as marginal revenue is greater than marginal cost, added output means added profit. zThe profit maximizing perfectly competitive firm will produce up to the point where the price of its output is just equal to the short run marginal cost; the level of output where: P* = MC or MR = MC.

Copyright 2002, Pearson Education Canada17 The Profit-Maximizing Level of Output for a Perfectly Competitive Firm (Figure 8.10)

Copyright 2002, Pearson Education Canada18 Marginal Cost Is the Supply Curve of a Perfectly Competitive Firm (Figure 8.11)

Copyright 2002, Pearson Education Canada19 Review Terms & Concepts zaverage fixed cost (AFC) zaverage total cost (ATC) zaverage variable cost (AVC) zfixed cost zmarginal cost (MC) zmarginal revenue (MR) zspreading overhead ztotal cost (TC) ztotal fixed cost (TFC) ztotal revenue (TR) ztotal variable cost (TVC) ztotal variable cost curve zvariable cost