MORE MICRO CHAPTER 20

Costs

AVERAGE FIXED COST (AFC)

Divide the total fixed cost by the output (Q) AFC = TFC/Q Since fixed costs are constant, AFC must

decline as output increases Referred to as “Spreading the Overhead”

MARGINAL COST (MC)

The extra or additional cost of producing 1 more unit of output

MC = change in TC/change in Q

AVERAGE VARIABLE COST (AVC)

Divide total variable cost by output TVC/Q AVC graph is “u” shaped

AVERAGE TOTAL COST (ATC)

ATC = TC/Q ATC = TFC/Q + TVC/Q ATC = AFC + AVC

LONG-RUN PRODUCTION COSTS

Long-Run ATC Curve

Long-RunATC

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sATC-1

ATC-2

ATC-3 ATC-4

ATC-5

Output

The Long-Run ATC Curve Just“Envelopes” the Short Run ATCs

MC intersectsBoth ATC and AVC at their min

Average and Marginal Costs

Costs

1 2 3 4 5 6 7 8 9 100 Q

50

100

150

$200

AFC

MC

ATCAVC

AVC

AFC

G 20.1

HOW IT APPLIES

When the amount (MC) added to total cost is less than the current average total cost, ATC will fall

When the marginal cost exceeds ATC, ATC will rise

SHIFTS OF THE COST CURVES

Changes in either resource prices or technology will cause costs to change and therefore the cost curves to shift

An increase in technology will shift the ATC curve downwards

An increase in resource prices would shift the curve upwards

ECONOMIES OF SCALE

Economies of Scale-Economies of mass production

Reduced per-unit cost as production increases

Reasons: labor and management specialization, efficient capital, per-unit advertising $$

DISECONOMIES OF SCALE

Increases in the average total cost of producing a product as the firm expands the size of its plant in the long run

***delayed communication, top-heavy company, isolation of decision makers, shirking (avoiding work)

CONSTANT RETURNS TO SCALE

Long run average costs do not change

LONG-RUN PRODUCTION COSTSAlternative Long-Run ATC Shapes

Output

Long-Run ATC Curve Where EconomiesOf Scale Exist

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Long-RunATC

EconomiesOf Scale

Constant ReturnsTo Scale

DiseconomiesOf Scale

q1 q2

SUNK COSTS

A cost that has already been incurred and can’t be recovered

Marginal Benefit v Marginal Cost Assuming you can’t resell the good Don’t cry over spilled milk