7/30/2019 Answer 4,5,6
1/17
4. Describe the various trajectories of different cost concepts. Include AFC, AVC, AC, MC
and TC.
TOTAL COST CURVES:
The total cost of producing a good can be represented by three related curves, total cost curve, total
variable cost curve, and total fixed cost curve. The total cost curve is the vertical summation of the
total variable cost curve and the total fixed cost curve.
Total Fixed Cost Curve: The total fixed cost (TFC) curve is a horizontal line.
Total fixed cost is equal to $3 and does not change with the quantity of output produced, thus the
TFC curve is a flat, horizontal line.
Total Variable Cost Curve: The total variable cost (TVC) curve is a positively-sloped line that reflects
increasing then decreasingmarginal returns
The TVC curve emerges from the origin with a relatively steep slope, flattens, then becomes
increasingly steeper.
The TVC for one article is $5, this then rises to $8 for two etc., finally reaching $43 for ten
Note:
From Quantity 0-3, there is Economies Of scale From Quantity 8-10, there is Diseconomies of Scale
http://pop_dsp%28%27pop_gls.pl/?k=marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=marginal%20returns%27,500,400)7/30/2019 Answer 4,5,6
2/17
.
Total Cost Curve: The total cost (TC) curve can be derived as the vertical summation of the TVCand TFC curves. In other words, the TC curve can be found by shifting the TVC vertically by the
amount of TFC. This means that the shape of the TC curve is identical to that of the TVC. The twocurves have identical slopes for each quantity of output.
Here vertical difference between the TC and TVC curves is exactly $3.00, the value of TFC.
All three curves together:
7/30/2019 Answer 4,5,6
3/17
An important conclusion from this derivation of the TC curve is that the vertical distance between TC
and TVC curves is the same at ALL output quantities. The reason, of course, is that this vertical
distance IS total fixed cost. Because total fixed cost is constant, the vertical distance is constant.
This further implies that the slopes of the TC and TVC curves are identical at each and every output
quantity. of total fixed cost. In other words, the TC and TVC curves are essentially the same curve,
the TC curve just happens to be a little bit higher in the diagram, higher by the amount of total fixed
cost.
Thus TC= TFC + TVC
AVERAGE FIXED COST:
Average fixed cost is thetotal fixed costper unit of output
average fixed cost =
total fixed cost
quantity of output
An alternative specification for average fixed cost is found by subtracting average variable cost from
average fixed cost:
average fixed cost = average total cost - average variable cost
The Average Fixed Cost Curve
The key feature of this average fixed cost curve is the shape. The average fixed cost curve is
negatively sloped. Average fixed cost is relatively high at small quantities of output, then declines as
production increases. The more production increases, then the more average fixed cost declines.
The reason behind this perpetual decline is that a given FIXED cost is spread over an increasingly
larger quantity of output.
Note: At any point on the curve Q* C=Constant
http://pop_dsp%28%27pop_gls.pl/?k=total%20fixed%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20fixed%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20fixed%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20fixed%20cost%27,500,400)7/30/2019 Answer 4,5,6
4/17
For example: A thousand dollars of fixed cost averages out to $10 per unit if only 100 units are
produced. But if 10,000 units are produced, then the average shrinks to a mere 10 cents per unit.Its Use:
Average fixed cost, when combined with price, indicates whether or not a firm should shut down
production in the short run. If price is greater than average fixed cost, then the firm is able to pay, at
least, fixed cost. Even though it might be incurring an economic loss, it will lose less by producing
than by shutting down production. If, however, price is less than average fixed cost, then the firm is
better off shutting down production.
AVERAGE VARIABLE COST:
Average variable cost is thetotal variable costper unit of output incurred when afirmengages
inshort-run production.
In general, average variable cost decreases with additional production at relatively small quantities
of output, then eventually increases with relatively large quantities of output. This pattern is
illustrated by a U-shaped average variable cost curve.
average variable cost =
total variable cost
quantity of output
An alternative specification for average variable cost is found by subtracting average fixed cost from
average total cost:
average variable cost = average total cost - average fixed cost
The Average Variable Cost Curve
http://pop_dsp%28%27pop_gls.pl/?k=total%20variable%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20variable%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20variable%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20variable%20cost%27,500,400)7/30/2019 Answer 4,5,6
5/17
The relation between average variable cost and the
quantity of production can be represented by a
curve
The key feature of this average variable cost is the
shape. It is U-shaped, meaning it has a negative
slopefor small quantities of output, reaches a
minimum value, then has a positive slope for larger
quantities. This U-shape is indirectly attributable to
thelaw of diminishing marginal returns.
The U-shape of the average variable cost curve is
indirectly caused by increasing, then decreasing
marginal returns (and the law of diminishing
marginal returns). The negatively-sloped portion is
attributable to increasing marginal returns and the
positively-sloped portion is attributable to
decreasing marginal returns (and the law of diminishing marginal returns).
Its Use:
Average variable cost, when combined withprice, indicates whether or not a firm should shut down
production in the short run. If price is greater than average variable cost, then the firm is able to pay
all variable cost and a portion of fixed cost. Even though it might be incurring an economic loss, it
will lose less by producing that by shutting down production. If, however, price is less than average
variable cost, then the firm is better off shutting down production.
AVERAGE TOTAL COST:
Averagetotal costis the total cost per unit of output incurred when afirm engages in short-run
production.
In general, average total cost decreases with additional production at relatively small quantities of
output, then eventually increases with relatively large quantities of output. This pattern is illustrated
by a U-shaped average total cost curve.
Calculating Average Total Cost
The standard method of calculating average total cost is to divide total cost by the quantity,
illustrated by this equation:
average total cost =
total cost
quantity of output
An alternative specification for average total cost is found by summing average variable cost and
average fixed cost:
Average Variable Cost Curve
http://pop_dsp%28%27pop_gls.pl/?k=slope%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=slope%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=law%20of%20diminishing%20marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=law%20of%20diminishing%20marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=law%20of%20diminishing%20marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=price%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=price%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=price%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=%20short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=%20short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=%20short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=%20short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=%20short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=total%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=price%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=law%20of%20diminishing%20marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=slope%27,500,400)7/30/2019 Answer 4,5,6
6/17
average total cost = average variable cost + average fixed cost
The Average Total Cost Curve
The key feature of this average total cost is the
shape. It is U-shaped, meaning it has a negative
slopefor small quantities of output, reaches a
minimum value, then has a positive slope for larger
quantities. This U-shape is indirectly attributable to
thelaw of diminishing marginal returns.
Its Use;
Average total cost, when combined with price,
determines per unitprofit or loss that a profit-
maximizing firm receives from short-run
production. If price is greater than average total
cost, then the firm receives positive economic
profitper unit. If price is less than average total
cost, the firm incurs a loss, or negative economic
profit, per unit. If price is equal to average total
cost, then the firm is just breaking even, receiving neither a per unit profit nor incurring a per unit
loss.
Average Total Cost Curve
http://pop_dsp%28%27pop_gls.pl/?k=slope%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=slope%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=law%20of%20diminishing%20marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=law%20of%20diminishing%20marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=law%20of%20diminishing%20marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economic%20profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economic%20profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economic%20profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economic%20profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economic%20profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=profit%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=law%20of%20diminishing%20marginal%20returns%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=slope%27,500,400)7/30/2019 Answer 4,5,6
7/17
5. Explain the relationship between AC & MC. Connect this to discussion on economies of
scale.
Marginal Cost:
Marginal cost is the change in total cost that arises when the quantity produced changes by one
unit. That is, it is the cost of producing one more unit of a good.
A typical Marginal Cost Curve
AC n MC:
http://en.wikipedia.org/wiki/File:Marginalcost.gifhttp://en.wikipedia.org/wiki/File:Marginalcost.gifhttp://en.wikipedia.org/wiki/File:Marginalcost.gif7/30/2019 Answer 4,5,6
8/17
The MC curve will intercept the AC curves at its minimum point. When AC is decreasing, MC lies
below AC - because when MC is below AC, producing an extra unit of output will pull down
average cots When AC is increasing, MC lies above AC - because when MC is above AC,
producing an extra unit of output will raise average costs Therefore MC will intercept the AC
curve at its minimum point
6. Relate LAC and SAC or Connect the plan (SAC) that the firm operates with given the
planning curve (LAC).
Another term for the long-run average cost curve (LRAC). Using the name planning curve
indicates that the long-run average cost curve is used to "making plans" especially
concerning the desired scale of operations of a firm. That is, in the long run a firm will seek
the plant size that maximizes long-run profit by equating long-run marginal cost and
marginal revenue. It will then pick out the appropriate plant size off the long-run average
cost with the minimum short-run average total cost.
PLANNING HORIZON:
Another term for the long-run average cost curve. The long-run average cost curve is termed the
planning horizon or planning curve because it provides information that a firm can use to plan factory
construction and expansion in the long run.
Along-run average costcurve, or planning curve, is displayed in the exhibit below. This
curve has the expected U-shape created byeconomies of scale(orincreasing returns toscale) for small quantities of output anddiseconomies of scale(ordecreasing returns toscale) for large output quantities. Of note is that this long-run average cost curve is an
envelope of several short-run average total cost curves.
Short and Long, Together
Long Run Average Cost
http://pop_dsp%28%27pop_gls.pl/?k=long-run%20average%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=long-run%20average%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=long-run%20average%20cost%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economies%20of%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economies%20of%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economies%20of%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=increasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=increasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=increasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=increasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=diseconomies%20of%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=diseconomies%20of%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=diseconomies%20of%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=decreasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=decreasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=decreasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=decreasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=decreasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=decreasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=diseconomies%20of%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=increasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=increasing%20returns%20to%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=economies%20of%20scale%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=long-run%20average%20cost%27,500,400)7/30/2019 Answer 4,5,6
9/17
To see why the long-run average cost curve is
termed a planning curve, a distinction between
the short-run and long-run operation offirmis in order. Short-run operation requires that afirm decide the quantity ofvariable inputs it needs in order to produce a given output, given
one or morefixed input. In other words, Waldo's TexMex Taco World must decide how manyworkers to employ and how much lettuce and sour cream to buy each day. But Waldo is not
really concerned with the size of the restaurant for day-to-day operation. The restaurant isa given.
When Waldo expects limited business on the weekdays, he purchases small quantities of
lettuce and sour cream and schedules only a handful of employees. However, when he
expects to sell more on the weekends, he schedules more employees and purchases more
lettuce and sour cream. In effect, Waldo is using a given short-run average and marginalcost curves such as the ones labeled SRATC(a) and SRMC(a) that can be revealed by
clicking the button labeled [Short Run]. Asdemand(and price) change in the short-run,Waldo adjusts his output quantity based on his marginal cost.
However, even as Waldo makes these day-to-day decisions aboutshort-run production, he
has his eye on the long run. He has plans to buy additionalcapitalequipment, add a fewmore tables and chairs, and expand the size of the restaurant. Even as Waldo schedules the
number of employees to work next Thursday, he is also reviewing architectural plans for the
new construction. Even as he orders extra boxes of lettuce for the weekend, he is making adecision between oak chairs or pine. In essence, a firm operates in both the short run andthe long run simultaneous.
Long Run Adjustment
Waldo's long run plans are intertwined with his day-to-day operation. If a firm determinesthat day-to-day operations are straining the capacity of the fixed input, then it is likely to
move ahead on plans to expand. Waldo, for example, realizes that his restaurant cannot
service all of his potential customers. Every day, a line of customers extends out the doorand circles the block. This is just the sort of thing that induces Waldo to expand hisrestaurant, to move from short run to the long run. In effect, Waldo is deciding if he should
shift his current short-run cost curves from SRATC(a) and SRMC(a), to another set. Clicking
the [Long Run Expansion] button reveals such a new set of curves, SRATC(b) and SRMC(b),associated with reducing the size of his restaurant.
However, if Waldo's restaurant is never more than half filled with day-to-day operations,
then he might decide to remodel his existing place or move to a smaller one. Once again,
Waldo intertwines the short run and the long run. In effect, Waldo is deciding if he should
shift his current short-run cost curves from SRATC(a) and SRMC(a), to another set. Clickingthe [Long Run Reduction] button reveals such a new set of curves, SRATC(c) and SRMC(c),associated with reducing the size of his restaurant.
http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=variable%20input%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=variable%20input%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=fixed%20input%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=fixed%20input%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=fixed%20input%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=demand%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=demand%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=demand%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=capital%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=capital%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=capital%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=capital%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=short-run%20production%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=demand%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=fixed%20input%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=variable%20input%27,500,400)http://pop_dsp%28%27pop_gls.pl/?k=firm%27,500,400)7/30/2019 Answer 4,5,6
10/17
The short-run average total cost curve (SATC or SAC)
Typical short run average cost curve
The average total cost curve is constructed to capture the relation between cost per unitand the level ofoutput,ceteris paribus. A productively efficient firm organizes itsfactors of
productionin such a way that theaverage costof production is at lowest point andintersects Marginal Cost. In theshort run, when at least one factor of production is fixed,
this occurs at the optimum capacity where it has enjoyed all the possible benefits ofspecializationand no further opportunities for decreasing costs exist. This is usually not U
shaped, it is a checkmark shaped curve. This is at the minimum point in the diagram on the
right.Example: Q=2K.5L.5STC=Pk(K)+Pw(Q2/4K) SATC or SAC= (Pk(K)/Q)+Pw(Q/4K)Shortrun average cost equals average fixed costs plus average variable costs. Average fixed cost
continuously falls as production increases. The shape of the average variable cost curve is
directly determined by diminishing marginal returns to the variable input (conventionallylabor).[1]Average variable cost eqauls w/APL or the wage rate divided by the average
product of labor.
The long-run average cost curve (LRAC)
http://www.answers.com/topic/outputhttp://www.answers.com/topic/outputhttp://www.answers.com/topic/outputhttp://www.answers.com/topic/ceteris-paribushttp://www.answers.com/topic/ceteris-paribushttp://www.answers.com/topic/ceteris-paribushttp://www.answers.com/topic/factors-of-productionhttp://www.answers.com/topic/factors-of-productionhttp://www.answers.com/topic/factors-of-productionhttp://www.answers.com/topic/factors-of-productionhttp://www.answers.com/topic/average-cost-2http://www.answers.com/topic/average-cost-2http://www.answers.com/topic/average-cost-2http://www.answers.com/topic/short-runhttp://www.answers.com/topic/short-runhttp://www.answers.com/topic/short-runhttp://www.answers.com/topic/specializationhttp://www.answers.com/topic/specializationhttp://www.answers.com/topic/cost-curve#cite_note-0http://www.answers.com/topic/cost-curve#cite_note-0http://www.answers.com/topic/cost-curve#cite_note-0http://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Av_Total_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Av_Total_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Av_Total_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Av_Total_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Av_Total_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Av_Total_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Av_Total_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Av_Total_Cost.PNGhttp://www.answers.com/topic/cost-curve#cite_note-0http://www.answers.com/topic/specializationhttp://www.answers.com/topic/short-runhttp://www.answers.com/topic/average-cost-2http://www.answers.com/topic/factors-of-productionhttp://www.answers.com/topic/factors-of-productionhttp://www.answers.com/topic/ceteris-paribushttp://www.answers.com/topic/output7/30/2019 Answer 4,5,6
11/17
Typical long run average cost curve
Essentially, the long-run average cost curve depicts what the minimum per-unit cost of
producing a certain number of units would be if all productive inputs could be varied. Given
that LRAC is an average quantity, one must not confuse it with the long-run marginal costcurve, which is the cost of one more unit. The LRAC curve is created as an envelope of an
infinitenumber of short-run average total cost curves. The typical LRAC curve is U-shaped,reflectingeconomies of scalewhen negatively-sloped anddiseconomies of scalewhen
positively sloped. Contrary to Viner, the envelope is not created by the minimum point ofeach short-run average cost curve. This mistake is recognized as Viner's Error.
In a long-runperfectly competitiveenvironment, the equilibrium level of output corresponds
to theminimum efficient scale, marked as Q2 in the diagram. This is due to the zero-profitrequirement of a perfectly competitive equilibrium. This result, which implies production is
at a level corresponding to the lowest possible average cost, does not imply that otherproduction levels are not efficient. All points along the LRAC are productively efficient, bydefinition, but are not equilibrium points in a long-run perfectly competitive environment.
In some industries, the LRAC is always declining (economies of scale exist indefinitely). Thismeans that the largest firm tends to have a cost advantage, and the industry tends
naturally to become a monopoly, and hence is called anatural monopoly. Naturalmonopolies tend to exist in industries with high capital costs in relation to variable costs,such aswater supplyandelectricity supply.
The average cost is the total cost divided by the number of units produced.
The marginal cost curve (MC)
Typical marginal cost curve
Amarginal costthat graphically represents the relation between marginal cost incurred by a
firm in the short-run product of a good or service and the quantity of output produced. This
curve is constructed to capture the relation between marginal cost and the level of output,holding other variables, like technology and resource prices, constant. The marginal costcurve is U-shaped. Marginal cost is relatively high at small quantities of output, then as
production increases, declines, reaches a minimum value, then rises. The marginal cost is
shown in relation to marginal revenue, the incremental amount of sales that an additional
http://www.answers.com/topic/infinityhttp://www.answers.com/topic/infinityhttp://www.answers.com/topic/economies-of-scale-2http://www.answers.com/topic/economies-of-scale-2http://www.answers.com/topic/economies-of-scale-2http://www.answers.com/topic/diseconomies-of-scalehttp://www.answers.com/topic/diseconomies-of-scalehttp://www.answers.com/topic/diseconomies-of-scalehttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/minimum-efficient-scalehttp://www.answers.com/topic/minimum-efficient-scalehttp://www.answers.com/topic/minimum-efficient-scalehttp://www.answers.com/topic/natural-monopolyhttp://www.answers.com/topic/natural-monopolyhttp://www.answers.com/topic/natural-monopolyhttp://www.answers.com/topic/water-supplyhttp://www.answers.com/topic/water-supplyhttp://www.answers.com/topic/water-supplyhttp://www.answers.com/topic/electric-powerhttp://www.answers.com/topic/electric-powerhttp://www.answers.com/topic/electric-powerhttp://www.answers.com/topic/marginal-costshttp://www.answers.com/topic/marginal-costshttp://www.answers.com/topic/marginal-costshttp://en.wikipedia.org/wiki/File:Costcurve_-_Marginal_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Marginal_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Marginal_Cost.PNGhttp://en.wikipedia.org/wiki/File:Costcurve_-_Marginal_Cost.PNGhttp://www.answers.com/topic/marginal-costshttp://www.answers.com/topic/electric-powerhttp://www.answers.com/topic/water-supplyhttp://www.answers.com/topic/natural-monopolyhttp://www.answers.com/topic/minimum-efficient-scalehttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/diseconomies-of-scalehttp://www.answers.com/topic/economies-of-scale-2http://www.answers.com/topic/infinity7/30/2019 Answer 4,5,6
12/17
product or service will bring to the firm. This shape of the marginal cost curve is directly
attributable to increasing, then decreasing marginal returns (and the law of diminishing
marginal returns -Diminishing returns). Marginal cost equal w/MPL. For most productionprocesses the marginal product of labor initially rises, reaches a maximum value and then
continuously falls as production increases. Thus marginal cost initially falls, reaches aminimum value and then increases.[2]
Combining cost curves
Cost curves inperfect competitioncompared to marginal revenue
Cost curves can be combined to provide information about firms. In this diagram for
example, firms are assumed to be in aperfectly competitivemarket. The marginal cost
curve will cut the average cost curve at its lowest point. In a perfectly competitive market a
firm's profit maximising price would be at or above the price at which the average costcurve cuts the marginal cost curve. If the marginal revenue is above the average total cost
price the firm is deriving an economic profit.
Cost curves and production functions
Assuming that factor prices are constant, the production function determines all costfunctions.[3]The variable cost curve is the inverted short run production function or total
product curve and its behavior and properties are determined by the production function.[4]
Because the production function determines the variable cost function it necessarilydetermines the shape and properties of marginal cost curve and the average cost functions
Productivity and costs in the longrun
In the long run both capital and labour are variable Firms can change the amount of machines or office space that they use Therefore, the law of diminishing returns does not determine the productivity of a
firm in the long run In the long run productivity and costs are driven by returns to scale
http://www.answers.com/topic/diminishing-returnshttp://www.answers.com/topic/diminishing-returnshttp://www.answers.com/topic/diminishing-returnshttp://www.answers.com/topic/cost-curve#cite_note-1http://www.answers.com/topic/cost-curve#cite_note-1http://www.answers.com/topic/cost-curve#cite_note-1http://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/cost-curve#cite_note-2http://www.answers.com/topic/cost-curve#cite_note-2http://www.answers.com/topic/cost-curve#cite_note-2http://www.answers.com/topic/cost-curve#cite_note-3http://www.answers.com/topic/cost-curve#cite_note-3http://www.answers.com/topic/cost-curve#cite_note-3http://en.wikipedia.org/wiki/File:Costcurve_-_Combined.pnghttp://en.wikipedia.org/wiki/File:Costcurve_-_Combined.pnghttp://en.wikipedia.org/wiki/File:Costcurve_-_Combined.pnghttp://en.wikipedia.org/wiki/File:Costcurve_-_Combined.pnghttp://www.answers.com/topic/cost-curve#cite_note-3http://www.answers.com/topic/cost-curve#cite_note-2http://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/perfect-competitionhttp://www.answers.com/topic/cost-curve#cite_note-1http://www.answers.com/topic/diminishing-returns7/30/2019 Answer 4,5,6
13/17
When a firm substitutes labour with machinery, and the investment makes the firm moreefficient, then the average cost curve would move down to the right as in the previous slide.
If investment does not increase productivity and does not change average costs then thecost curve does not change.
Long run average cost curve
The long run average cost curve is simply a collection of short run average cost curves,
illustrating how average costs change as fixed inputs (plant size, type and number ofmachines etc) change. LAC/ Envelope Curve
The LAC is also called the planning curve because it is a guide to the entrepreneur forplanning the future expansion of the firm and choosing the optimal scale or plant size forthe production.
Returns to scale
Returns to scale measures the change in output for a given change in inputs Increasing returns to scale exist when output grows at a faster rate than inputs Decreasing returns exist when inputs grow at a faster rate than outputs Constant returns to scale exist when inputs and outputs grow at the same rate
Costs in the Long Run
All inputs that are under the firms control can be varied there are no fixed costs (all inputs are flexible) Long run is best thought of as a planning horizon irms plan for the long run, but they produce in the short run
Long-Run Planning Curve
7/30/2019 Answer 4,5,6
14/17
Firms Long-Run Planning Curve
7/30/2019 Answer 4,5,6
15/17
Alternate answer to Q6:
To study the shape of the AC curve, we have to consider both- the SRAC and LRAC.
Given any point on avg cost curve, the corresponding x-axis value tells you the quantity output,
and corresponding y-axis value tells you the avg cost ie cost/unit for producing that output.
Multiplying both you get the Total cost.
SRAC-
1. The short-run cost curves are normally based on a production function with one variablefactor of production that displays first increasing and then decreasing marginal
productivity. Increasing marginal productivity is associated with the negatively sloped
portion of the marginal cost curve, while decreasing marginal productivity is associated
with the positively sloped portion.
2. The average fixed cost (AFC) curve is the cost of the fixed factor of production divided bythe quantity of units of the output, while the average variable cost (AVC) curve cost
traces out the per unit cost of variable factor of p bnroduction.
3. The U-shaped avqerage total cost (ATC) curve is derived by adding the average fixedand variable costs.
7/30/2019 Answer 4,5,6
16/17
4. Increasing average costs occur when the effect of declining marginal productivityoverwhelms the effect of spreading the fixed costs.
7/30/2019 Answer 4,5,6
17/17
LRAC
The long-run cost curves, are also expressed most commonly in their average, or per unit, form,
represented in Figure 2.
The long-run average cost (LRAC) curve is shown to be an envelope of the short-run average
cost (SRAC) curves, lying everywhere below or tangent to the short-run curves.
If there are a discrete number of plant sizes available, the LRAC will be the scalloped curve
obtained by joining those parts of the SRAC curves that represent the lowest cost of production
for a given quantity.
Recommended