Short-run costs and output decisions 8 CHAPTER. Short-Run Cost Total cost (TC) is the cost of all productive resources used by a firm. Total fixed cost.

Short-run costs and output decisions 8CHAPTER

Short-Run Cost

Total cost (TC) is the cost of all productive resources used by a firm.

Total fixed cost (TFC) is the cost of all the firm’s fixed inputs.

Total variable cost (TVC) is the cost of all the firm’s variable inputs.

Total cost (TC) is the cost of all productive resources used by a firm.

TC = TFC + TVC

Total Cost Curves

Total Total

fixed variable Total

cost cost cost

Labor Output (TFC) (TVC) (TC)

(workers (sweaters

per day) per day) (dollars per day)

a 0 0

b 1 4

c 2 10

d 3 13

e 4 15

f 5 16

Total Cost Curves

Total Total

fixed variable Total

cost cost cost

Labor Output (TFC) (TVC) (TC)

(workers (sweaters

per day) per day) (dollars per day)

a 0 0 25

b 1 4 25

c 2 10 25

d 3 13 25

e 4 15 25

f 5 16 25

Total Cost Curves

Total Total fixed variable Total cost cost cost

Labor Output (TFC) (TVC) (TC)(workers (sweatersper day) per day) (dollars per day)

a 0 0 25 0

b 1 4 25 25

c 2 10 25 50

d 3 13 25 75

e 4 15 25 100

f 5 16 25 125

Total Cost Curves

Total Total

fixed variable Total

cost cost cost

Labor Output (TFC) (TVC) (TC)

(workers (sweaters

per day) per day) (dollars per day)

a 0 0 25 0 25

b 1 4 25 25 50

c 2 10 25 50 75

d 3 13 25 75 100

e 4 15 25 100 125

f 5 16 25 125 150

Total Cost Curves

TCCTC

TVC

0 5 10 15

50

100

150

Cos

t (do

llars

per

day

)

TFC

TC = TFC + TVC

Output (sweaters per day)

Marginal Cost

Marginal cost is the increase in total cost that results from a one-unit increase in output.

It equals the increase in total cost divided by the increase in output.

Marginal costs decrease at low outputs because of the gains from specialization, but it eventually increases due to the law of diminishing returns.

Average Cost

Average fixed cost (AFC) is total fixed cost per unit of output.

Average variable cost (AVC) is total variable cost per unit of output.

Average total cost (ATC) is total cost per unit of output.

Average Cost

ACTC = TFC + TVC

TC TFC TVC

Q Q Q= +

OR

ATC = AFC + AVC

Marginal Cost and Average Costs

MC

MC

ATC

AVC

AFC

0 5 10 15

5

10

15C

ost (

dolla

rs p

er s

wea

ter)

ATC = AFC + AVC

Economic Profit and Revenue

Total revenue is the value of a firm’s sales.

Total revenue = P Q

Marginal revenue (MR)

Change in total revenue resulting from a one-unit increase in quantity sold.

Average revenue (AR)

Total revenue divided by the quantity sold—revenue per unit sold.

In perfect competition, Price = MR = AR

Total Revenue, Total Cost, and Economic Profit

TR, TCTC

Quantity (sweaters per day)

Tot

al r

even

ue &

tota

l cos

t (

doll

ars

per

day)

0 4 9 12

100

300

183

225

TR

Economicloss

Economicprofit =TR - TC

Economicloss

Total Revenue, Total Cost, and Economic Profit

EP

Quantity (sweaters per day)

4 9 12-20

0

-40

42

20

Profitmaximizing quantity

Profit/loss

Economicprofit

Economicloss

Prof

it/l

oss

(do

llar

s pe

r da

y)

Economic profit/loss

Marginal Analysis

If MR > MC, the extra revenue from selling one more unit exceeds the extra cost.

The firm should increase output to increase profit.

If MR < MC, the extra revenue from selling one more unit is less than the extra cost.

The firm should decrease output to increase profit.

If MR = MC economic profit is maximized

Profit-Maximizing Output

MA

8 9 10

10

20

30

MR25

MCProfit-maximizationpoint

Loss from10th sweater

Profit from9th sweater

0

Mar

gina

l rev

enue

& m

argi

nal c

ost

(do

llar

s pe

r da

y)

Quantity (sweaters per day)

A Firm’s Supply Curve

SC

MR2

MR1

Quantity (sweaters per day)7 9 10

17

25

31

Mar

gina

l rev

enue

& m

argi

nal c

ost

(do

llar

s pe

r da

y) MC = S

MR0

AVC

s

Shutdown point

0

A Firm’s Supply Curve

SC

7 9 10

17

25

31

Mar

gina

l rev

enue

& m

argi

nal c

ost

(do

llar

s pe

r da

y) S

s

0

The Firm’s Decisions in Perfect Competition

In the short-run, the firm must decide:

Whether to produce or to shut down.

If the decision is to produce, what quantity to produce.

Three Possible Profit Outcomes in the Short-Run

NP

Pri

ce (

dolla

rs p

er c

hip)

15.00

20.00

25.00

8 10

30.00

AR = MR

MC ATCBreak-evenpoint

Normal profit

0 Quantity (millions of chips per year)

Three Possible Profit Outcomes in the Short-Run

EP

EconomicProfit

0

Pri

ce (

dolla

rs p

er c

hip)

15.00

20.33

25.00

9 10

30.00

AR = MR

MC ATC

Economic profit

Quantity (millions of chips per year)

Three Possible Profit Outcomes in the Short-Run

EL

Economicloss

AR = MR17.00

20.14

25.00

30.00

MC ATC

Economic loss

7 100 Quantity (millions of chips per year)

THE END