Cost Curve Model Chapter 13 completion

Costs of Production Fixed costs - do not change with quantity of output Variable costs - ↑ with quantity of output Marginal cost ∆ total cost to make 1 extra unit Fixed Costs + Variable Costs = Total Costs

pasta Shape of MC Curve Shape of MC curve is determined by shape of MP Curve If MP ↑ => MC ↓ If MP ↓ => MC ↑ MC

Model: uses average cost curves: uses economic costs ATC = TC / Qty produced AVC = TVC / Qty produced AFC = TFC / Qty produced Cost Curve Model Cost Curves

Using Average Cost Curves Quantity of Output Costs $ MC ATC AVC AFC MC hits both ATC & AVC at their minimum When MC average total cost is falling When MC > ATC => average total cost is rising AFC always declines: Fixed Costs spread over more output ATC is U-shaped Due to high fixed costs

1) Profit = TR – TC There are several formulas to calculate economic profit: 2) Profit = (Price – ATC) X Qty (most useful formula) Market Price = P 1 If P 1 > ATC => Economic Profit If P 1 Economic Loss Cost Curves

Economies of Scale Economies of scale = Qty ↑ => ATC ↓ –ATC falls as output increases –Allows for specialization of workers –Leads to more productivity 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

Practice Test

Short Run vs. Long Run Costs Costs depends on the 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

Long Run ATC Quantity of Cars per Day 0 Average Total Cost 1,200 $12,000 1,000 10,000 Economies of scale Diseconomies of scale Constant returns to scale LRATC Note! => The “term” economies of scale applies only to long run cost curves

Long Run vs. Short Run ATC LRATC is always below or on short run ATC curve –you can be more efficient in long run!