3.3.2 Costs Flashcards
Short run
The period in which a firm in unable to vary the input of at least one of its factors, while being able to change all of the other
- at least one factor of production is fixed
- fixed and variable costs
Long run
All inputs can be varied
- all factors of production are variable
- only variable costs
Fixed cost
Independent of output level
- e.g ads, rent
Variable costs
Depend on the level of output
- e.g staff
Total cost (short run) definition
Total cost to produce a given level of output (an increase in output = increase in total costs
Total cost formula
Total cost = total fixed cost + total variable cost
Total variable cost
In the long run, all factors input can change meaning all costs are variable (change with output)
- e.g staff
Total fixed cost
In the short run, at least one factor of production cannot change meaning there are some fixed costs (do not vary with output)
Average price level
The output of producing at an extra unit of cost
Marginal cost (short run)
Additional cost of producing one extra unit of output (once MC gets too high, the MPL is diminishing)
Marginal cost formula
∆TC/∆Q (new total cost- old total cost/new quantity-old quantity)
Average total cost (short)
Total cost ÷ quantity of output produced (TC/Q)
Average variable cost
Variable cost ÷ quantity of output (VC/Q)
Average fixed cost
Fixed cost ÷ quantity of output (FC/Q)
Short run cost curves diagram
Relationship between marginal cost & average variable cost & short run average total cost
- SAVC curve falls when the short run marginal cost curve is below it & rises when the short run marginal cost curve is above it
- thus, the two curves cross at the lowest point on the average cost curve
Short run cost curves explanation
- Looking at the MC curve (this is the increase in total cost, variable cost, when output increases by a unit)
- to produce an additional unit of output requires labour input. Thus labour demand is a derived demand
- Labour is a variable factor & combined with capital, which is a fixed factor in the short-run, produces output
Marginal product of labour
company’s increase in total production when one additional unit of labor is added
Marginal product of labour formula
∆Q/∆L
Average product of labour
(The labour needed to product an extra unit of output) measure of how much each worker produces, on average. You simply divide total product by the number of employees.
Average product of labour formula
Q/L
Diminishing marginal product of labour/productivity graph
Diminishing marginal product of labour/productivity
- adding more units of a variable input to a fixed input, increase output at first. But after a certain no. Inputs are added, the marginal increase of output remains constant
- then when there is an even greater input, the marginal increase in output starts to fall
Diminishing marginal product of labour example
Adding more workers
- marginal product increases without the first few additions of workers (specialisation). Workers are more efficient when they specialise in production & work together to produce a good
- eventually MP decreases (law of diminishing returns. At some point, each additional worker contributes less output than the worker before
Why does diminishing marginal product of labour happen?
Production can lead to bottlenecks because capital is fixed- workers are waiting for machinery to become open
How can MP be negative?
Capital is fixed in the short run. If more and more workers keep getting added, they will get in each other’s way & actually cause output to fall
Total product curve graph
Total product curve
- As unit of output increases by one, less labour is needed up to a certain point
- If output is fixed, but labour is decreasing, then firms can pay less wage for labour = less cost needed = higher profit
- If marginal product is diminishing an increasingly larger amount of labour is required for each additional unit of output
Example of total product curve
If wage rate is fixed: MC = wage rate ÷ MPL
- MC falls if MPL is increasing & increases if MPL is falling
-
Short run cost curves with diminishing marginal product
- MC, ATC and AVC rise with diminishing returns. AFC falls with increased output
- Highlighted are the points in which DMP sets in. Before this, AC is creasing. After AC is increasing
Long run cost curves graph
Long run cost curve explanation
- LRAC curve falls when the LMC curve is below it & rises when the LMC is above it
- Thus two curve cross at the lowest point on the AC curve
- If fixed costs are high, AC decreases as output increases
- When diseconomies of scale set in, AC increases (long run)
Relationship between SRAC and LRAC graph
Relationship between SRAC and LRAC
- LRAC curve envelopes the SRAC curve & is always equal to or below the SRAC
- LRAC shifts when there are external economies of scale (e.g industry growing)
- SRAC falls at first, then rises due to diminishing returns
- If SRAC = LRAC, the firm operates where it can vary all factor inputs
Returns to scale and LAC
Returns to scale can determine the LAC shape
Returns to scale (LAC) graph
Returns to scale example
Increased economies of scale…
…(due to increased output) increased research and development, increased quality, decreased price = increased consumer surplus
Marginal cost
- the increase in total cost, variable cost, when output increases by a unit
A firm which prints greetings card records its short run costs. It observes that the average cost per card decreases s more are produced, although the marginal cost is rising. It follows that…
Marginal costs are below average costs
Suppose that your firm operates on the rising segment of its long-run average total cost curve. in order to produce output at a lower average cost you must
Reduce output and build a smaller plant
If a firm is producing at the lowest point of ATC, to be productively efficient…
The firm should increase its level of output
What happens to the graph when there’s a change in fixed costs?
AC curve moves
What curve does fixed costs shift?
AC curve
What curve does variable costs shift?
AC and revenue
