Output and Costs

Short-Run Cost

• To produce more output in the short run, the firm must employ more labour, which means that it must increase its costs

Total cost (TC)

• The cost of all resources used

Total fixed cost (TF)

• The cost of the firm's fixed inputs
• Do not change with output

Total variable cost (TVC)

• The cost of the firm's variable inputs
• Change with the outout

Relationship:

$TC=TFC+TVC$

Total cost curves

Marginal Cost (MC)

• The increase in total cost that results from a one-unit increase in total product
  • Increasing marginal returns => marginal cost falls as output increases
  • diminishing marginal returns => marginal cost rises as output increases

Average fixed cost (ACF)

• Total fixed cost per unit of output

Average variable cost (AVC)

• Total variable cost per unit of output

Average total cost (ATC)

• Total cost per unit of output

Relationship:

$ACT=AFC+AVC$

Cost Curves and Product Curves

• The shape of a firm's cost curves are determined by the technology it uses
  • By the shape of the total product curve
• MC _is at its minimum at the same output level at which _MP is at its maximum
• When MP is rising, MC is falling
• AVC is at its minimum at the same output level at which AP is at its maximum

• When AP is rising, AVC is falling

• The AVC curve is U-shaped because

  • Initially MP exceeds AP, which brings rising AP and falling AVC
  • Eventually MP falls below AP, which brings falling AP and AVC

• The ATC curve is U-shaped for the same reasons

  • The ATC falls at low output levels because AFC is falling quickly
  • ATC curve is the vertical sum of the AFC curve and the AVC curve
  • Influence of two opssing forces
    • Spreading total fixed cost over a larger output - AFC curve slopes downward as output increases
    • Eventually diminishing returns - the AVC curve slopes upwards and AVC increases more quickly than AFC is decreasing

Shifts in the cost curves

• The position of a firm's cost cruves depend on techonlogy and prices of factors of production

Technology

• Influences both the product curves and the cost curves
• Increase in productivity shifts the product curves upward and the cost curves downward
• If the technological advance results in the firm using more capital and less labour, fixed costs increase and variable cost decrease
• Average total cost increase at low output levels and decreases at output levels

Prices

• Increase in the price of a factor of production increases costs and shifts the cost curves
• Increase in a fixed cost shifts the TC and ATC upwards but does not shift the MC curve
• Increase in a variable cost shifts the TC, ATC, and MC curves upward

Long-Run Cost

• All inputs are variable and all costs are variable
• Depends upon on the firm's product function - the relationship between the maximum output attainable and the quantitiesof both capital and labour

Diminishing Marginal Product of Capital

Marginal product of capital - the increase in output resulting from a one-unit increase in the amount of capital employed, holding constant the amount of labour employed

• A firm's production function exhibits diminishing marginal returns to labour (for a given plant) and diminishing marginal returns to capital (for a quantity of labour)
• Creates a set of short run, U-shaped cost curves for MC, AVC, and ATC

Short and Long-Run Cost

• The larger the plant, the greater it the output at which ATC is at a minimum
• Each plant has a short-run ATC curve
  • The firm can compare the ATC for each output at different plants

Long-Run Cost

• Made up from the lowest ATC for each output level

• By comparing the curves using differnet numbers of knit machines, we can see that the least-cost way of producing 13 sweater a day is to use 2 knitting machines ($ATC_2$)

Long-run average cost curve - the relationship between the lowest attainable average total cost and output when both the plant and the labour are varied

• A planning curve that tells the firm the plant that minimizes the cost of producing a given output range

Economies and Diseconomies of Scale

Economies of scale - falling long-run average cost as output increases (e.g. technology)

Diseconomies of scale - rising long-run average cost as output increases

Constant returns to scale - constnat long-rn average costs as output increases

Minimum Efficient Scale

• The smallest quantity of output at which the long-run average cost reaches its lowest level
• If the long-run average cost curve is U-shaped, the minimum point identifies the minimum scale output level