CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 1 of 31 COSTS IN THE SHORT RUN Accounting cost : Accounting cost is also known as explicit cost; that is explicitly paid for factors of production such as salary, raw material, electricity, insurance, taxes, …etc. Opportunity cost : Opportunity cost is also known as implicit cost ; cost that is not actually paid for the factors of production, but it sacrificed for the sake of using existing factors of production available at the work place

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 31 COSTS IN THE SHORT RUN Example of Opportunity cost : If a company owns a warehouse and uses it to store products, the company will not pay rent for the usage of this warehouse because the company owns it. The opportunity cost of using the warehouse is renting, and benefiting from the rent.

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 31 COSTS IN THE SHORT RUN So, Accounting Cost = Explicit cost only Economic cost = Explicit cost + Implicit Cost If Implicit Cost = 0, Accounting cost = Economic cost

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 31 COSTS IN THE SHORT RUN Normal and Economic Profits Normal Profits is the Accounting profits Accounting Profits = Total Revenue – Accounting Cost Accounting Profits = TR – Explicit Cost Economic Profits = Total Revenue – Economics Cost Economic Profits = TR – ( Explicit Cost + Implicit Cost ) 1. If TR ˃ Economics Cost, the company gains economic profits 2. If TR ˂ Economics Cost, the company gains economic loss 3. If TR = Economics Cost, economic profits = 0 and the company gains only normal profits.

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 31 COSTS IN THE SHORT RUN fixed cost Any cost that does not depend on the firm’s level of output. These costs are incurred even if the firm is producing nothing. variable cost A cost that depends on the level of production chosen. total cost (TC) Fixed costs + variable costs.

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 31 COSTS IN THE SHORT RUN total fixed costs (TFC) The total of all costs that do not change with output, even if output is zero. Total Fixed Cost (TFC) FIXED COSTS TABLE 8.1 Short-Run Fixed Cost (Total and Average) of a Hypothetical Firm (1) Q (2) TFC (3) AFC (TFC/Q) $1,000 $1,000 $1,000 $  1,

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 31 COSTS IN THE SHORT RUN average fixed cost (AFC) Total fixed cost divided by the number of units of output; a per-unit measure of fixed costs. Average Fixed Cost (AFC)

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 31 COSTS IN THE SHORT RUN spreading overhead The process of dividing total fixed costs by more units of output. Average fixed cost declines as quantity rises. FIGURE 8.2Short-Run Fixed Cost (Total and Average) of a Hypothetical Firm

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 9 of 31 COSTS IN THE SHORT RUN total variable cost (TVC) The total of all costs that vary with output in the short run. Total Variable Cost (TVC) VARIABLE COSTS total variable cost curve A graph that shows the relationship between total variable cost and the level of a firm’s output.

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 31 COSTS IN THE SHORT RUN The total variable cost curve embodies information about both factor, or input, prices and technology. It shows the cost of production using the best available technique at each output level given current factor prices. FIGURE 8.3Total Variable Cost Curve

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 31 COSTS IN THE SHORT RUN Marginal Cost (MC) marginal cost (MC) The increase in total cost that results from producing one more unit of output. Marginal costs reflect changes in variable costs.

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 31 COSTS IN THE SHORT RUN Average Variable Cost (AVC) average variable cost (AVC) Total variable cost divided by the number of units of output.

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 31 COSTS IN THE SHORT RUN QTFCTVCTCAFCAVCATCMC

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 31 COSTS IN THE SHORT RUN QTFCTVCTCAFCAVCATCMC

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 31 COSTS IN THE SHORT RUN FIGURE 8.7Total Cost = Total Fixed Cost + Total Variable Cost TOTAL COSTS

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 31 The following could be concluded 1.When the AVC curve is ˃ MC, AVC is decreasing 2.When the AVC curve is ˂ MC, AVC is increasing 3. The same speech is applied for ATC and MC 4. AVC crosses the MC curve at its lowest point (Shut-down point) at that point AVC = $3, and Q = 3 units which is the least AVC value. 5. The shut-down point enables the firm to minimize the losses to the minimum.

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of ATC crosses the MC curve at its lowest point ( the Breakeven point ) when TR = TC at Q =5 and ATC = $18 7. The ATC curve always remains higher than the AVC curve, the more the production increases, the more curves get closer but never touch. 8. The vertical distance between ATC and AVC is the AFC. 9. The AFC curve descends downwards to the right hand side and get close to the horizontal axis without touching it. This means that AFC is decreasing but never equal zero 10. As long as the AFC curve doesn’t touch the horizontal axis, both the ATC and AVC will not touch

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 18 of 31 The Relationship between Cost and Production Curves in the Short Run Average Variable Cost (AVC) and Average Production of Labour ( APL )

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 19 of 31 The Relationship between Cost and Production Curves in the Short Run

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 20 of 31 If the wage per worker a month = $ 300 LQ = TPLMPLAPLTVC = W.LAVCMCTFCTC

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 21 of 31 If the wage per worker a month = $ 300 LQ = TPLMPLAPLTVC = W.LAVCMCTFCTC

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair Profit Maximization: The Numbers QPTRTCTP = TR-TC MRMCATC 0$1$0$1.00-$1.00$1 1 $2.00-$1.00$1$1.00$2.00 2$1$2$2.80-$0.80$1$0.80$1.40 3$1$3$3.50-$0.50$1$0.70$1.17 4$1$4$4.00$0.00$1$0.50$1.00 5$1$5$4.50$0.50$1$0.50$0.90 6$1$6$5.20$0.80$1$0.70$0.87 7$1$7$6.00$1.00$1$0.80$0.86 8$1$8$6.86$1.14$1$0.86 9$1$9$7.86$1.14$1$1.00$ $1$10$9.36$0.64$1$1.50$ $1$11$12.00-$1.00$1$2.64$1.09 MR=MC

CHAPTER 8: Short-Run Costs and Output Decisions © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair TCTR 0 Total cost, revenue $ Quantity Profit Determination Using Total Cost and Revenue Curves Maximum profit =$81 $130 Loss Profit Profit =$45 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.