AP Micro Quiz 10

Fixed Cost (overhead cost)

Does not depend on the quantity of output produced. It is the cost of the fixed input

Variable Cost

Depends on the quantity of output produced. It is the cost of the variable input

Total Cost

Fixed cost plus variable cost

Total Cost Curve

Shows how total cost depends on the quantity of output

Always upward sloping curve, with slope steepening as output rises due to diminishing returns on labor

Marginal Cost

The change in total cost caused by producing one more unit of output. Equal to the slope of the total cost curve

Marginal Cost Calculation

Change in total cost / change in quantity of output

Marginal Cost Curve

The relationship between marginal cost and output

Average Cost

Overall total cost / quantity of output

Average Total Cost Curve

U-shaped, falls at low levels of output, then rises at higher levels

Average Fixed Cost

Fixed cost per unit of output (fixed cost / quantity of output)

Average Variable Cost

Variable cost per unit of output(variable cost/quantity of output)

Interpreting Average Total Cost Curve

At low levels of output, the average total cost falls because the “spreading effect” of falling average fixed cost dominates the “diminishing returns effect” of rising average variable cost

Spreading Effect

The larger the output, the greater the quantity of output over which the fixed cost is spread, leading to a lower average fixed cost

Diminishing Returns Effect

The larger the output, the greater the amount of the variable unit required to produce additional units, leading to a higher average variable cost

Minimum Cost Output

The quantity of output where average total cost is lowest. It corresponds to the bottom of the U-Shaped ATC curve

At minimum-cost output, average total cost equals marginal cost

If output < minimum-cost output, marginal cost is less than average total cost, and average total cost is falling

If output > minimum-cost output, marginal cost exceeds average total cost, and average total cost is rising.

Marginal & Average Cost Relationship

If the marginal cost is less than average total cost, an increase in output reduces average total cost

If the marginal cost is greater than average total cost, an increase in output increases average total cost

Short Run Production Costs

If marginal cost goes down, marginal product goes up

If marginal cost goes up, marginal product goes down

If average product goes up, average variable cost goes down

If average product goes down, average variable cost goes up

Long-Run Average Total Cost Curve

Shows the relationship between output and ATC when fixed cost has been chosen to minimize average total cost for each level of output.

When output levels change significantly, so does the amount of capital that minimizes long-run average total cost.

Economies of scale

When long-run average total cost declines as output increases

Buying in bulk, cheaper capital or technology advancement, more effective management

Increasing returns to scale

When output increases more than in proportion to an increase in all inputs

For example: inputs increase by 50% and output increases by 100%

Minimum efficient scale

Smallest quantity at which a firm’s long-run average total cost is minimized

A company can produce product at a competitive price relative to other firms in the industry

Diseconomies of scale

When long-run average total cost increases as output increases

Distant and effective management firm, or scale of production is too large

Decreasing returns to scale

Occurs when output increases less than a proportional increase in all inputs

For example: inputs increase by 50% and output increases by 20%

Constant returns to scale

Occur when output increases directly in proportion to an increase in all inputs

For example: inputs increase by 50% and output increases by 50%

Diminishing Returns

Short run concept because at least one input is being held constant

Returns to scale

Long run concept because all inputs are variable