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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