9/13/2015 ©2000Claudia Garcia-Szekely 1 Short Run Costs Costs when the plant size is fixed

Expenses that do not change with the number of units produced Raw Materials Wages Rent Interest Payments Secretaries Property Taxes Insurance Managers Fixed Cost Expenses that change with the number of units produced Variable Cost

Raw Materials Wages Variable Cost Rent Interest Payments Secretaries Property Taxes Insurance Managers Fixed Cost

4 Some labor costs are fixed. Management Salaries are a fixed cost, because they do not change with the firm’s output.

Production Function Quantity Produced (Q) $ Costs Labor (L) Quantity Produced (Q) Cost Function

Fixed Costs: Do not change with Q Q FC =40000 Q=500Q=10,000 $40,000 FC = Q=0 Rent Interest Payments Secretaries Property Taxes Insurance Managers Fixed Cost

Variable Costs increase with Output Output Starts at the Origin VC Raw Materials Wages Variable Cost

Total Costs = FC+VC Output Starts at FC FC Starts at the Origin TC VC

9 Output FC VC TC Distance between the TC and VC = FC

10 Output VC=? VC TC FC

11 Output VC = 400 TC = 600 FC =200 VC = 300 TC = 500 FC =200 VC = 300

From MP to MC

Wage =$50/day Assume that labor is the ONLY variable cost 1 worker = $50 2 workers = $100 3 workers = $150

From MP to MC

Marginal Cost MC =  VC/  Q $50/5=$10 $50/10=$5 $50 5units $50 10units MC = wage /MP $50/15=$3.3 $50/20=$2.5 $50/17=$2.9 $50/15=$3.3 $50/13=$3.8 MPWage

From MP to MC MC = wage / MP Increasing MP =Decreasing MC Wage is the same Decreasing MP =Increasing MC Wage is the same MC =  VC/  Q

From MP to MC

MP Labor Units of Output MC As the MP increases The MC decreases MC As the MP decreases The MC increases When the MP is at its Maximum The MC is at its Minimum Diminishing Returns to Labor set in Q0Q0 L0L0

From VC to TC: add FC 19 TC = FC + VC 50,000 = FC + VC 50,000 = FC + 0 FC = 50,000 TC = FC + VC 50,000 = FC + VC 50,000 = FC + 0 FC = 50,000 Variable cost of producing zero units = 0 Total cost of producing zero units = 50,000 50,000

20 Marginal Cost Cost of “the last” unit produced. –When one more unit is produced, the fixed cost does not change. –Is the cost of labor, raw materials and other variable expenses incurred when producing an additional unit.

Marginal Cost Formula MC =  TC/  Q MC = (  FC +  VC) /  Q Because  TC =  VC when one more unit is produced, we can also write: MC =  VC/  Q Marginal cost is the additional Variable Cost of producing one more unit  FC = 0 MC is the slope of both the TC and the slope of the VC MC = rise/run MC = slope MC = rise/run MC = slope TC and VC have the exact same slope TC and VC have the exact same shape

22 Total Cost = Fixed Cost + Variable Cost

23 Total Cost = Fixed Cost + Variable Cost

LQMPVCMCFCTCMC MC can be calculated using the VC or the TC Q5Q5  TC 50  VC 50 MC  VC/  Q MC  TC/  Q  TC 50  VC 50  Q 10

LQMPVCMCFCTCMC MC  VC/  QMC  TC/  Q

Marginal Cost Tells you how the Variable cost changes as more output is produced It is the slope of the Variable Cost 26 MC  VC/  Q

Variable Cost Output Increasing function The MC decreases MC The MC increases Steps get smaller MC Steps get larger QVC QVCMC Slope Decrease Slope Increase MC decrease Steps get smaller MC Increase Steps get larger Starts at the Origin

Marginal Cost Tells you how the Variable cost changes as more output is produced Tells you how the Total cost changes as more output is produced Both the VC and the TC change by the SAME amount. 28 MC  VC/  Q MC  TC/  Q

Total Costs Output Starts at FC FC The MC decreases MC The MC increases Steps get smaller MC Steps get larger Starts at the Origin TC VC TC has the same slope (shape)as the VC

9/13/2015 ©2000Claudia Garcia-Szekely 30 Per Unit Costs Average Costs

Average (per unit) Costs TC = FC + VC To get per unit costs, divide by Q (Units Produced) TC/Q = FC/Q + VC/Q ATC = AFC + AVC 31

32 Fixed Costs Fixed Costs do not change with the level of output (Q) We show this by drawing a horizontal line. Fixed Costs Q FC =40K when Q=2 Q=2 Q=10 40K FC = 40K when Q=10

33 Average Fixed Costs Q Q=2Q= AFC Average Fixed Cost AFC =20 when Q=2 AFC = 4 when Q=10 FC = 40 Q = 2 AFC = 40/2 = 20 AFC = 40/10 = 4 AFC = 40/5 = 8 8 Q=5 Q = 10 Even though FC remains the same: 40k The Average Fixed Cost Decrease as output increase

Variable Costs Output AVC = VC / Q AVC = Slope of ray from origin AVC = rise / run Minimum AVC AVC Q VC Rise = VC Run = Q As Q increase, slope decrease: AVC decrease

Variable Costs Output AVC = Slope of ray from origin Minimum AVC As Q increase, slope increase: AVC increase AVC

TC ATC = Slope of ray from origin Minimum ATC As Q increase, (slope) ATC decrease Output (Q) ATC Rise = TC Run = Q ATC = TC / Q As Q increase, (slope) ATC decrease reaches a minimum and then increase

37 Q=2 Q=10 9 AVC = AVC ATC = AVC + AFC AFC AFC = AFC = 4 4 ATC 19 AVC =9 ATC =29 ATC = 19 AVC AFC ATC

Q=2 Q= AVC AVC, AFC, ATC 29 ATC 19 AFC Distance between the ATC and AVC = AFC

The Relationship between Average and Marginal costs If MC > Average Cost, the Average Cost increase. If MC < Average Cost, the Average Cost decrease. If MC = Average Cost, the Average Cost does not increase or decrease: it is maximum. 39 AVC or ATC

Q MC MC < AVC AVC ATC MC > AVC, MC < ATC, MC > ATC, MC = AVC, AVC minimum MC = ATC, ATC minimum AVC decrease AVC increase ATC increase ATC decrease

MP AP MP, AP L MC AVC Q MC, AC AP is max MP is max AVC is min MC is min

42 MC cuts the ATC and the AVC at their MINIMUM points ATC,AVC, MC AVC MC ATC Reach Minimum at different Output levels Min AVC Min ATC Min MC: Diminishing returns to labor set in

From Average Costs to Total Costs ATC = TC/Q AVC = VC/Q AFC = FC/Q TC =ATC x Q VC = AVC x Q FC = AFC x Q Rearrange as

44 Per unit Costs MC AVC ATC AVC Q VC TC AVC x Q = VC AFC x Q = FC ATC x Q = TC AFC =ATC - AVC FC MC Cost of producing the LAST unit

TC = 120*20 FC = 120*(20-10) VC = 120*10 For Q = 120 ATC = 20 AVC = 10 Cost of producing the120 th unit 20 AFC=20 -10= 10

For Q = 300 TC = 300*24 FC = 300*(24-20) VC = 300*20