Short-Run Production Costs

Fixed, Variable, and Marginal Cost

• Fixed Cost: costs that do not change with the level of output produced

• Variable Cost: costs that vary with the level of output produced

• Marginal Cost: the cost of producing one additional unit of output

MC, AVC, ATC

• Marginal cost : cost difference of one additional unit of output (∆TC/∆Q)

• Average fixed cost (AFC) : FC/Q

• Average variable cost (AVC) : VC/Q

• Average total cost (ATC) : TC/Q or AFC + AVC

• Total Cost = TFC + ATC

Graph

• The MC curve intersects both the AVC and ATC curves at their respective lowest points

  • This intersection signifies the output level where average costs are minimized

Marginal Revenue and Marginal Cost

• Marginal Revenue: the additional revenue a firm earns by selling one more unit of a good or service; (change in TR/change in Q)

• Marginal Cost: the additional cost incurred by producing one more unit of a good or service (change in TC/change in Q)

  • MC typically decreases initially due to increasing returns, then increases due to diminishing returns.

• Profit Maximization Rule is when MR = MC

• TR is at maximum when MR goes negative

MR Below ATC

• When MR < ATC, the firm is not covering its total costs and is operating at a loss

• Even if a firm is incurring losses (MR < ATC), it may continue operating in the short run if it can cover its average variable costs (AVC).

• continuing operations allows the firm to contribute to fixed costs, potentially reducing overall losses compared to shutting down immediately

• if losses persist in the long run, the firm may exit the market, as it's unsustainable to operate without covering total costs over time

How Costs Change when Fixed and Variable Costs Change

1. Changes in Fixed Costs:

• Fixed costs (e.g., rent, salaries) remain constant regardless of output

• Increasing fixed costs raises the AFC and ATC

• However, MC and AVC remain unaffected because fixed costs don't change with production levels

2. Changes in Variable Costs:

• Variable costs (e.g., raw materials, hourly wages) fluctuate with output

• An increase in variable costs raises AVC, MC, and ATC

• These changes directly impact the cost of producing each additional unit​

3. Graphical Representation:

• An increase in fixed costs shifts the ATC curve upward, while MC and AVC curves remain unchanged

• An increase in variable costs shifts the AVC, MC, and ATC curves upward

4. Changes in Productivity:

• Improved productivity (e.g., better technology) allows more output with the same input

• This causes the AVC, MC, and ATC curves to shift downward, indicating lower costs per unit

• Conversely, reduced productivity shifts these curves upward