Principles of Microeconomics - Short-Run Costs and Output Decisions

Chapter 8: Short-Run Costs and Output Decisions

8.1 Costs in the Short Run

• Fixed Costs:

  • Any cost that does not vary with output (q); incurred even at zero production. Absent in the long run.

• Total Fixed Cost (TFC):

  • All costs constant regardless of output. Graphically, a horizontal line (TFC = \text{Constant Value}).

• Spreading Overhead:

  • Distributing fixed costs over more units to lower average fixed costs. The Average Fixed Cost (AFC) curve is always downward-sloping, as AFC = \frac{TFC}{q}.

• Variable Costs:

  • Costs that change directly with output level.

• Total Variable Cost (TVC):

  • Sum of all variable costs as output varies. The TVC curve generally increases with output, reflecting initial increasing and then diminishing returns (e.g., TVC = wL if L is variable input).

• Marginal Cost (MC):

  • Additional cost from producing one more unit of output; reflects changes in variable costs. Typically U-shaped due to diminishing returns. Calculated as MC = \frac{\Delta TVC}{\Delta q} or MC = \frac{dTVC}{dq}.

• Average Variable Cost (AVC):

  • Total variable cost per unit of output: AVC = \frac{TVC}{q}. U-shaped, intersects MC at its minimum. When MC \< AVC, AVC falls; when MC > AVC, AVC rises.

Total Costs

• Total Cost (TC):

  • Sum of TFC and TVC: TC = TFC + TVC. Graphically, the TC curve mirrors the TVC curve, shifted upward by TFC.

• Average Total Cost (ATC):

  • Total cost per unit of output: ATC = \frac{TC}{q} or ATC = AFC + AVC. U-shaped, intersects MC at its minimum. The vertical gap between ATC and AVC narrows as AFC decreases with output.

Output Decisions: Revenues, Costs, and Profit Maximization

Perfect Competition Overview

• Perfect Competition:

  • Industry structure with many small firms, homogeneous products, and no individual pricing control.

• Homogeneous Products:

  • Products indistinguishable to consumers.

Revenue Analysis

• Total Revenue (TR):

  • Total income from sales: TR = \text{Price per Unit} \times \text{Quantity Sold}. In perfect competition, with constant price (P), TR is an upward-sloping straight line from the origin: TR = P \times q.

• Marginal Revenue (MR):

  • Incremental revenue from selling an additional unit. In perfect competition, MR = P. Graphically, MR is a horizontal line at the market price, coinciding with the firm's demand curve (P = MR = AR).