Cost Curve Model Chapter 13 completion
3 Costs of Production Total Costs = Fixed Costs + Variable Costs Fixed costs - do not change with quantity of output Fixed costs are SUNK! Variable costs - ↑ with quantity of output Marginal cost ∆ total cost to make 1 extra unit Total Costs = Fixed Costs + Variable Costs
Cost Curve Model Model: uses average cost curves: uses economic costs ATC = TC / Qty produced AVC = TVC / Qty produced AFC = TFC / Qty produced
There are several formulas to calculate economic profit: 1) Profit = TR – TC Cost Curves 2) Profit = (Price – ATC) X Qty (most useful formula) Market Price = P1 If P1 > ATC => Economic Profit If P1 < ATC => Economic Loss
Shape of MC Curve Shape of MC curve is determined by shape of MP Curve pasta pasta Shape of MC curve is determined by shape of MP Curve pasta MC If MP ↑ => MC ↓ If MP ↓ => MC ↑ pasta pasta pasta pasta pasta
Using Average Cost Curves MC hits both ATC & AVC at their minimum Costs When MC < ATC => average total cost is falling When MC > ATC => average total cost is rising $3.00 2.50 MC ATC AVC AFC ATC is U-shaped Due to high fixed costs 2.00 1.50 1.00 AFC always declines: Fixed Costs spread over more output 0.50 2 4 6 8 10 12 14 Quantity of Output
Economies of Scale Economies of scale = Qty ↑ => ATC ↓ ATC falls as output increases Allows for specialization of workers Leads to more productivity (MP) per worker Diseconomies of scale = Qty ↑ => ATC ↑ ATC rises as output increases coordination problems eventually arise as firms grow in size Constant returns to scale- Qty ↑ => ATC stays the same
Short Run vs. Long Run Costs Costs depends on time horizon considered In the short run, some costs are fixed In the long run, all fixed costs become variable costs Why? => Firms have time to change both plant size & labor force Therefore, long-run cost curves differ from short-run cost curves Minimum of long run ATC is always at or below short run ATC
Long Run vs. Short Run ATC LRATC is always at or below short run ATC curve you can be more efficient in long run!