ap economics: module 55 terms

fixed cost (FC)

a cost that does not depend on the quantity of ouput produced; the cost of the fixed input

• also called an overhead cost

variable cost (VC)

a cost that depends on the quantity of output produced; the cost of the variable input

total cost

sum of the fixed cost and variable cost of producing a quantity of output

• TC = FC + VC

total cost curve

shows how total cost depends on the quantity of output

• slopes upward: ↑output, diminishing returns lead to ↑VC → ↑TC

as output increases, what happens to the TPC and the TCC?

TPC → increases and gets flatter

TCC → increases and gets steeper

*both due to diminishing returns to inputs

*as output increases, MC increases b/c MP of variable input decreases

marginal cost

the change in TC generated by producing one more unit of output

• MC = ΔTC/ΔQ

• essentially ΔVC/ΔQ in the short run

slope of TC

MC

slope of TP

MP

average total cost (ATC)/average cost

total cost divided by quantity of output (cost per unit of output); equal to the sum of AFC and AVC

• ATC = TC/Q

• ATC = AFC + AVC

U-shaped ATC curves

fall @ low levels of output, then rise at higher levels

ATC curve

shows how ATC depends on output

2 components of ATC

AFC and AVC

average fixed cost (AFC)

fixed cost per unit of output

• FC/Q

average variable cost (AVC)

variable cost per unit of output

• VC/Q

why is the ATC curve U-shaped?

AFC and AVC move in opposite directions as output increases

• AFC↓ as output↑ → spreading effect (numerator constant, denominator increasing)

• AVC↑ as output↑ → diminishing returns effect (increased variable input needed for each unit of output)

2 opposing effects increasing output has on AVC

1. spreading effect

2. diminishing returns effect

spreading effect

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

diminishing returns effect

the larger the output, the greater the amount of the variable input required to produce additional units, leading to a higher AVC

spreading vs. D.R. effects at different levels of output

@ low output → spreading dominates D.R.

• small increases in output → large decrease in AFC

• ATC slopes downward

@ high output → D.R. dominates spreading

• AFC is already small, increases in output have a small spreading effect

• D.R ↑ as output rises

• ATC slopes upward

@ bottom of ATC → effects balance

• ATC is @ a minimum

why does MC slope upward?

diminishing marginal returns

why does AVC slope upward?

diminishing marginal returns

why is the AVC curve flatter than the MC curve?

the higher cost of an additional unit is averaged in AVC

why does AFC slope downward?

spreading effect

where does MC intersect ATC?

intersects ATC from below at minimum-cost output

minimum-cost output

the quantity of output at which ATC is lowest (the bottom of the U)

comparing MC and ATC at different values

@ minimum-cost output

• ATC = MC, bottom of U, ATC is constant

@ output < minimum-cost output

• MC < ATC, downward part of U, ATC falls

@ output > minimum-cost output

• MC > ATC, upward part of U, ATC rises

why does MP slope downward?

diminishing returns

why does MC actually have a “swoosh” shape?

initial downward slope @ low output

• employing workers → specialization

• increasing returns to labor → MC↓

• makes MC↓ and MP↑

upward slope @ higher output

• after some point → diminshing returns to labor

• MC starts ↑ and “swooshes” upward

• for same reason, AVC is a U

relationship between MP and MC

move in opposite directions

average product

of an input, the total product divided by the quantity of the input

average product curve

for an input, shows the relationship between the average product and the quantity of the input

relationship between AP and AVC

move in opposite directions

relationship between MC and ATC

• ATC will fall as long as the MC<ATC

• MC rises so that MC>ATC, the ATC will begin to rise

• If the MC of the next unit is equal to the current ATC, ATC will not change