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

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Presentation on theme: "9/13/2015 ©2000Claudia Garcia-Szekely 1 Short Run Costs Costs when the plant size is fixed."— Presentation transcript:

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2 9/13/2015 ©2000Claudia Garcia-Szekely 1 Short Run Costs Costs when the plant size is fixed

3 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

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

5 4 Some labor costs are fixed. Management Salaries are a fixed cost, because they do not change with the firm’s output.

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

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

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

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

10 9 Output FC VC TC Distance between the TC and VC = FC

11 10 Output 500 600 400 10002000 VC=? VC TC FC

12 11 Output 500 600 400 1000 2000 VC = 400 TC = 600 FC =200 VC = 300 TC = 500 FC =200 VC = 300

13 From MP to MC

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

15 From MP to MC

16 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

17 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

18 From MP to MC

19 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

20 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

21 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.

22 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

23 22 Total Cost = Fixed Cost + Variable Cost

24 23 Total Cost = Fixed Cost + Variable Cost

25 LQMPVCMCFCTCMC 00 0 50000 155505000050050 215101005000050100 330151505000050150 450202005000050200 567172505000050250 682153005000050300 795133505000050350 8107124005000050400 9117104505000050450 1012585005000050500 1113165505000050550 1213656005000050600 MC can be calculated using the VC or the TC Q5Q5  TC 50  VC 50 MC  VC/  Q MC  TC/  Q 10.00 5.00  TC 50  VC 50  Q 10

26 LQMPVCMCFCTCMC 00 0 50000 1555010.00500005005010.00 215101005.0050000501005.00 330151503.3350000501503.33 450202002.5050000502002.50 567172502.9450000502502.94 682153003.3350000503003.33 795133503.8550000503503.85 8107124004.1750000504004.17 9117104505.0050000504505.00 1012585006.2550000505006.25 1113165508.3350000505508.33 12136560010.00500005060010.00 MC  VC/  QMC  TC/  Q

27 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

28 Variable Cost Output Increasing function The MC decreases MC The MC increases Steps get smaller MC Steps get larger QVC 00 550 15100 30150 50200 67250 82300 95350 107400 117450 125500 131550 136600 QVCMC 00 55010 Slope Decrease 151005 301503.3 502002.5 672502.9 Slope Increase 823003.3 953503.8 1074004.2 1174505 1255006.3 1315508.3 13660010 MC decrease Steps get smaller MC Increase Steps get larger Starts at the Origin

29 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

30 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

31 9/13/2015 ©2000Claudia Garcia-Szekely 30 Per Unit Costs Average Costs

32 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

33 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

34 33 Average Fixed Costs Q Q=2Q=10 4 20 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

35 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

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

37 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

38 37 Q=2 Q=10 9 AVC = 15 15 AVC ATC = AVC + AFC AFC AFC =20 29 20 AFC = 4 4 ATC 19 AVC =9 ATC =29 ATC = 19 AVC AFC ATC

39 Q=2 Q=10 9 15 AVC AVC, AFC, ATC 29 ATC 19 AFC Distance between the ATC and AVC = AFC

40 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

41 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

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

43 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

44 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

45 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

46 10 120 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

47 46 10 20 24 40 50120300 44 For Q = 300 TC = 300*24 FC = 300*(24-20) VC = 300*20

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