Short-run Production CostsThis is a featured page

Fixed, Variable, and Total Costs:
  • Fixed Cost: costs that do not change with the level of output. Even if you produce nothing, you must still pay your fixed costs.
    • Beyond current control
    • Examples: Rental payments, interest on a firm's debts, insurance premiums, and a portion of deprecation on equipment and buildings, insurance premiums
  • Variable Cost: costs that change with the amount of output. Total Variable Costs are the sum of all of the variable costs, and costs that change with level of output.
    • Variable costs first increase by a decreasing amount, but later it increase by increasing amounts (due to MP curve)
    • Examples: payments for materials, fuel, power, transportation services, labor, etc.
    • Can be controlled in the short run by changing production levels
  • Total Cost: The sum of fixed cost and variable cost at each level of output
    • increases by the same amount as variable cost
    • Because the total cost is simply the variable cost + fixed cost, it is a graphically simple curve to outline.
TC = TFC + TVC

Short-run Production Costs - Welker's Wikinomics Page

    • Area between TC (total cost) and TVC (total variable cost) equals the TFC (total fixed costs), since TC-TVC=TFC.

    Per Unit, or Average, Costs
    • AFC: average fixed costs which is the total fixed cost divided by the quantity
      • AFC = TFC/Q
      • declines as output increases (spreading the overhead)
    • AVC: average variable costs which is the total variable cost divided by the quantity
      • AVC = TVC/Q
      • declines as variable resources (labor) increase output, reaches a minimum, and then increases again as the Law of Diminishing Returns sets in
      • at the low levels of output production is relatively inefficient and costly.
    • ATC: Average Total Cost
      • ATC = TC/Q = TFC/Q + TVC/Q = AFC + AVC
      • Can be found graphically by adding vertically the AFC and AVC curves
      • Vertical distance between ATC and AVC curves measures AFC at any level of output
      • The vertical distance between ATC and AVC curves will continue to decrease, as the AFC continues to decrease.
    Short-run Production Costs - Welker's Wikinomics Page

    Marginal Cost
    • Calculations: (ΔTC / ΔQ)
    • Marginal decisions: Since marginal cost indicates the extra cost of producing one more unit of production, firms can decide how many units to produce in order to save production costs most effectively.
    • Graphical portrayal:
    Short-run Production Costs - Welker's Wikinomics Page


    Marginal cost first falls sharply but suddenly rises, depicting that variable costs + total costs increase at first at a decreasing rate and then at an increasing rate.

    • Marginal Decisions: A firm's decisions as to what output level to produce are typically marginal decisions, i.e., decisions to produce a few more or a few less units.
    • MC and MP:Marginal product and marginal cost are reflective. When marginal product increases, marginal cost decreases. However, when diminishing returns set in, additional output requires more cost so marginal cost increases when marginal product decreases
      • Marginal product is the amount of product produced from each additional worker. Thus, as long as the marginal product of each worker rises, the marginal cost of retaining that worker will decrease. Where the law of diminishing returns sets in is where the marginal product of each worker is no longer rising, and therefore the marginal cost of retaining each additional worker will rise. (Paper Chain Link experiment)
    • Relation of MC to AVC and ATC:
      The Marginal Cost curve intersects the Average Variable Cost (AVC) curve and the Average Total Cost (ATC) curve at their minimum point. This is because when Marginal Cost is below the Average Variable Cost and the Average Total Cost, they decrease, whereas when MC is above the AVC or the ATC, they increase.
      • Why does this happen for AVC?
        • Diminishing returns effect: The more output produced, the more variable input required to produce more units.
      • Why does this happen for the ATC?
        • Spreading out effect: Initially, with rises in output, fixed costs are spread out over all the units of output, thereby decreasing AFC and therefore, the ATC.
        • Diminishing returns effect: The more output produced, the more variable input required to produce more units.
      • For example: If your econ average was a 90 , but then you got an 80 on your test, your average would drop. However if your econ average was a 90 but you got an 100 on your test, your average would rise.

      Shifts of the Cost Curves:
      • change in resource cost
      • change in technology
      • When the price of labor or some other variable input rise, AVC, ATC, and MC would rise and those cost curves would all shift upward.
      • The MC curve and the AVC curve are mirror images of the MP and AP curves.
      • When MP rises, MC falls, and vice versa.
      • When AP rises, AVC falls, and vice versa.



      JonathanRanstrand
      JonathanRanstrand
      Latest page update: made by JonathanRanstrand , Dec 14 2008, 10:32 AM EST (about this update About This Update JonathanRanstrand Edited by JonathanRanstrand

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