PowerPoint Presentation
Short-run Cost Theory
All inputs have a cost
Premises must be rented or purchased, often using a mortgage
which has to be paid back.
Equipment must also be rented or purchased. It also costs money
to maintain the equipment and power to run it.
Workers must be paid a wage..
Fixed factors of production have fixed costs. In other words,
the cost does not vary in the short-term as output changes.
Variable factors of production have variable costs. In other
words, the cost changes as output changes.
Which of the factors on the left are fixed and which are
variable?
http://t0.gstatic.com/images?q=tbn:ANd9GcTNE7DNracnJOGB8ji-rxEdLWjxgMZCcwxXut45uScMBTRXFlFoi6_lUDQ:www.appliedphotonics.co.uk/images/Facilities/premises(700x430).jpghttp://t1.gstatic.com/images?q=tbn:ANd9GcToa_l2wL4bibX7iwnXdA5Y0TJEsjgnjnZKUYN8gyvJEmv6iCsXX7vzaWO1:www.listersgeotechnics.com/images/site/site_equipment.jpghttp://t0.gstatic.com/images?q=tbn:ANd9GcQh99StskrD6t1GrehIkITr8dbq_c1Drg_DiBVZ-BjpRT5gVn_-iBJdW08:cdn2.benzinga.com/files/workers.jpg
Total Costs
The total cost of production at a particular level of output can
be calculated by working out the total fixed costs and adding the
total variable cost of production.
Total Cost = Total Fixed Cost + Total Variable Cost
To understand the effect of changing levels of output on the
productivity of the firm we often look at the average cost per
unit. This can be calculated by dividing the cost by the number of
units produced.
TC=FC+VC
Average Total Cost = Average Fixed Cost + Average Variable
Cost
ATC=AFC+AVC
Fixed Costs
Fixed costs, such as rent payments, are incurred even if a firm
produces nothing. As production increases, in the short-run these
costs remain the same. Shown on a graph (left) the TFC line is
horizontal.
If we consider a firm which produces only one unit in a period
of time, this single unit would bear the full fixed cost. As
production increases, the fixed costs are shared amongst more units
and the AFC falls rapidly at first, reaching and sustaining a very
low level at higher levels of output (as shown in the lower
left-hand graph).
Costs ()
Output
TFC
0
Costs ()
Output
AFC
0
Variable and Marginal Costs
Variable costs include factors such as labour which vary as
production levels change. However, the change is not directly
proportional to output.
As production levels rise, increasing marginal returns occur due
to the division of labour. Eventually, diminishing marginal returns
occur as the variable factor of production (e.g. labour) increases
in relation to the fixed factor (e.g. capital). Therefore, the
average and marginal costs incurred as output levels increase falls
to begin with, before rising as marginal returns diminish.
The average and marginal cost curves therefore mirror the
average and marginal product curves.
Output
Workers
MP
0
AP
Costs ()
Output
MC
0
AVC
Q1
Q2
Average and marginal product
Average and marginal cost
Average Total Costs
Remember the rule:
ATC = AFC + AVC
Thus the ATC curve is the total of the AFC and AVC curves.
The ATC curve is U-shaped. At first, ATC falls due to two
effects;
Falling average fixed costs as these are shared between more
units
Falling marginal costs due to division of labour
The ATC curve begins to rise as diminishing marginal returns
outweighs the effects of continued falls in AFC.
Costs ()
Output
MC
0
AVC
Q1
Q2
Adding AFC to AVC to obtain the ATC curve
AFC
ATC
Note that the MC curve intersects the AVC and ATC curves at
their lowest points.
Summary
TC = TFC + TVC
ATC = AFC + AVC
AFC falls as fixed costs are shared between more units of
output
Variable, and therefore marginal, costs fall due to increasing
marginal returns then rise due to increasing marginal returns
The U-shaped ATC curve is the sum of the AFC and AVC curves
ATC falls due to falling AFC and AVC, then rises as diminishing
marginal returns 'pulls up' costs despite continued decreases in
AFC
Costs ()
Output
MC
0
Q1
Q2
AFC
ATC
It is usual to show only the ATC and MC curves when constructing
models of firm's revenues and costs. However, it is important to
know how the ATC curve is derived.
A simplified cost diagram for a firm.
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
Click to edit Master title style
Click to edit Master subtitle style
Click to edit Master title style
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
Click to edit Master title style
Click to edit Master text styles
Click to edit Master title style
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
Click to edit Master title style
Click to edit Master text styles
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
Click to edit Master text styles
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
Click to edit Master title style
Click to edit Master title style
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
Click to edit Master text styles
Click to edit Master title style
Click to edit Master text styles
Click to edit Master title style
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
Click to edit Master title style
Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
