PRINCIPLE OF ECONOMIC
6 EDITION
KARL CASE, RAY FAIR
PRENTICE HALL BUSINESS PUBLISHING
COPY RIGHT 2002
Costs in the Short Run
•
The short run is a period
of time for which two conditions hold:
1.
The firm is operating under a fixed
scale (fixed factor) of production, and
2.
Firms can neither enter nor exit an
industry.
•
In the short run, all firms have costs
that they must bear regardless of their output.
These kinds of costs are called fixed costs.
•
Fixed cost
is any cost that does not depend on the firm’s level of output. These costs are incurred even if the firm is
producing nothing.
•
Variable cost
is a cost that depends on the level of production chosen.
Fixed Costs
•
Firms have no control over fixed costs
in the short run. For this reason, fixed
costs are sometimes called sunk costs.
•
Average fixed cost (AFC)
is the total fixed cost (TFC) divided by the number of units of output (q):
Variable Costs
•
The total variable cost curve
is a graph that shows the relationship between total variable cost and the
level of a firm’s output.
•
The total variable cost is derived from
production requirements and input prices.
Marginal Cost
•
Marginal cost (MC)
is the increase in total cost that results from producing one more unit of
output.
•
Marginal cost reflects changes in
variable costs.
The Shape of the Marginal Cost Curve in the Short
Run
•
The fact that in the short run every
firm is constrained by some fixed input means that:
1.
The firm faces diminishing returns to
variable inputs, and
2.
The firm has limited capacity to produce
output.
•
As a firm approaches that capacity, it
becomes increasingly costly to produce successively higher levels of output.
Graphing Total Variable Costs and Marginal Costs
•
Total variable costs always increase
with output. The marginal cost curve
shows how total variable cost changes with single unit increases in total
output.
•
Below 100 units of output, TVC
increases at a decreasing rate. Beyond
100 units of output, TVC increases at an increasing rate.
Average Variable Cost
•
Average variable cost (AVC)
is the total variable cost divided by the number of units of output.
•
Marginal cost is the cost of one
additional unit. Average variable cost
is the average variable cost per unit of all the units being produced.
•
Average variable cost follows
marginal cost, but lags behind.
Relationship Between Average Variable Cost and
Marginal Cost
•
When marginal cost is below average
cost, average cost is declining.
•
When marginal cost is above average
cost, average cost is increasing.
•
Rising marginal cost intersects average
variable cost at the minimum point of AVC.
Total Costs
•
Adding TFC to TVC means
adding the same amount of total fixed cost to every level of total variable
cost.
•
Thus, the total cost curve has the same
shape as the total variable cost curve; it is simply higher by an amount equal
to TFC.
Average Total Cost
•
Average total cost (ATC) is total
cost divided by the number of units of output (q).
•
Because AFC falls with output, an
ever-declining amount is added to AVC.
Relationship Between Average Total Cost and Marginal
Cost
•
If marginal cost is below average total
cost, average total cost will decline toward marginal cost.
•
If marginal cost is above average total
cost, average total cost will increase.
•
Marginal cost intersects average total
cost and average variable cost curves at their minimum points.
Output Decisions:
Revenues, Costs, and Profit Maximization
•
In the short run, a competitive firm
faces a demand curve that is simply a horizontal line at the market equilibrium
price.
Total Revenue (TR) and Marginal Revenue (MR)
•
Total revenue (TR)
is the total amount that a firm takes in from the sale of its output.
•
Marginal revenue (MR)
is the additional revenue that a firm takes in when it increases output by one
additional unit.
•
In perfect competition, P = MR.
Comparing Costs and Revenues to Maximize Profit
•
The profit-maximizing level of output
for all firms is the output level where MR = MC.
•
In perfect competition, MR = P,
therefore, the profit-maximizing perfectly competitive firm will produce up to the
point where the price of its output is just equal to short-run marginal cost.
•
The key idea here is that firms
will produce as long as marginal revenue exceeds marginal cost.
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