1. Costs in the Short Run

2. Fixed Costs & Average Fixed Costs
The labor-output relationship involves different types of costs.
Fixed costs (FC): are costs that do not vary with changes in output
Example; Rental payments, interest on a firm’s debt, depreciation, and insurance premiums.
Average fixed costs (AFC): is the fixed cost per unit of output
AFC = FC ÷ Quantity

3. Variable Costs
Variable costs (VC): are costs that change with the level of output
Example; Materials, labor, fuel

4. Average Variable & Marginal Cost
Average variable cost (AVC): is the variable cost per unit of output
Marginal variable cost (MVC): ∆VC ÷ ∆Quantity

5. Total Cost
Total Cost: is the sum of all fixed and variable costs at each quantity of output
TC = FC + VC

6. Average Cost & Marginal Cost
Average cost (AC): is the sum of average fixed cost (AFC) and average variable cost (AVC) at each quantity of output
AC = AFC + AVC
Alternatively, AC= TC ÷ Quantity
Marginal cost (MC): is the extra cost for an additional unit of output
MC= ∆TC ÷∆Quantity

7. Marginal Cost
Marginal decisions are very important in determining profit levels for firms
Marginal cost is a reflection of marginal product and diminishing returns
The marginal cost is related to AVC and ATC
As soon as the marginal cost rises above the average the averages will begin to rise

8. Shape of the AVC and MC Curves
Question: Why are the AVC and MC curves U-shaped?
Key Idea: Each additional worker adds the same amount to total cost but a different amount to total output
AVC:
1) Increasing APL implies decreasing AVC
2) Diminishing APL of the variable factor implies rising AVC
3) AVC is at its minimum when APL reaches its maximum
MC:
1) Increase MPL implies decreasing MC
2) Diminishing MPL of the variable factor implies rising MC
3) MC is at its minimum when MPL reaches its maximum

9. Per Unit Short-Run Production Costs
There are several key relations of MC to AVC and ATC
When MC < current ATC then ATC will fall
When MC > current ATC then ATC will rise
MC intersects ATC and AVC at minimum points

10. Example; Short-Run Costs for T-Shirts
Total Product 80
200
250
270
280
Fixed
Costs
825
Variable
Costs
140
300
425
535
640
Total
Costs
825
965
1125
1250
1360
1465
∆Total
Costs
140
160
125
110
105
Marginal Cost
1.75
1.33
2.50
5.50
10.50
AFC
10.31
4.13
3.30
3.06
2.95
AVC
1.75
1.50
1.70
1.98
2.29 AC
12.06
5.63
5.00
5.04
5.24

11. Shifts of the Costs Curves
Changes in either resource prices or technology will cause costs to change and therefore the cost curves to shift.
Changes in fixed cost shifts the AFC and the ATC curves, but AVC and MC would remain the same since variable costs are independent of fixed costs.
Changes in the price of labor or some other variable input shifts AVC, ATC, and MC.

12. Profit Maximizing Equilibrium
Recall, that a firms main objective is to maximize profits
A profit maximizing firm will produce at a point where it will makes the largest profit.
This occurs where total revenue exceeds total cost by the largest amount

13. Alternatively, marginal revenue (MR) and marginal costs (MC) can be used to determine the profit maximizing equilibrium
The firm examines the costs and revenue of producing an additional unit of output
If MR < MC then the firm is making a loss on the additional unit and should reduce its output
If MR > MC then the firm is making a profit on the additional unit and should increase its output
If MR = MC then the firm is in equilibrium and maximizing profit
At any other point more profit can be made by expanding or contracting output towards this point