Today’s Topic— Production and Costs of Production

output Variable input TP Diminishing Marginal Returns MP Diminishing Marginal Returns

Cost Classifications FIXED COSTS– Costs that stay the same no matter how much output is produced Costs that increase with the level of output

TC = FC + VC ATC = TC Q MC = = Δ TC Δ Q Rising marginal cost as output increases implies diminishing marginal product.

Big Bob’s Cost Curves

Figure 6 Big Bob’s Cost Curves Copyright © 2004 South-Western (a) Total-Cost Curve $ Quantity of Output (bagels per hour) TC Total Cost 0

Figure 6 Big Bob’s Cost Curves Copyright © 2004 South-Western (b) Marginal- and Average-Cost Curves Quantity of Output (bagels per hour) Costs $ MC ATC AVC AFC

Typical Cost Curves Three Important Properties of Cost Curves –Marginal cost eventually rises with the quantity of output. –The average-total-cost curve is U-shaped. –The marginal-cost curve crosses the average- total-cost curve at the minimum of average total cost.

ATC– A U-shaped Curve $ Q ATC

What happens to AFC as output increases? Output LevelTotal Fixed CostAverage Fixed Cost 1$100 10$100$10 50$100$2 100$100$1

Relationship of AVC to ATC-- v A U-shaped curve v Lies “below” ATC v Its minimum point is slightly to the left of ATC minimum point v Vertical distance between ATC and AVC  as output  $ Q AVC ATC AVC min ATC min

Relationship of MC to AVC --  MC is a U-shaped curve  MC intersects AVC at its minimum point  Minimum point on MC lies to left of minimum point of AVC  If MC > AVC, then AVC is rising  If MC < AVC, then AVC is falling $ Q MC AVC MC min AVC min

Relationship of MC to ATC--  MC intersects ATC at its minimum point  Minimum point on MC lies to left of minimum point of ATC  If MC > ATC, then ATC is rising  If MC < ATC, then ATC is falling $ Q MC ATC MC min ATC min

Cost Curves and Their Shapes Relationship Between Marginal Cost and Average Total Cost efficient scale –The marginal-cost curve crosses the average-total-cost curve at the efficient scale. Efficient scale is the quantity that minimizes average total cost. Is this profit max??????????

COSTS IN THE SHORT RUN AND IN THE LONG RUN –In the short run, some costs are fixed. –In the long run, fixed costs become variable costs. Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.

Economies of scale refer to the property whereby long-run average total cost falls as the quantity of output increases. Diseconomies of scale refer to the property whereby long-run average total cost rises as the quantity of output increases. Constant returns to scale refers to the property whereby long-run average total cost stays the same as the quantity of output increases

Figure 7 Average Total Cost in the Short and Long Run Copyright © 2004 South-Western Quantity of Cars per Day 0 Average Total Cost 1,200 $12,000 1,000 10,000 Economies of scale 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 Diseconomies of scale Constant returns to scale