1. 1 Costs in a Graph The curves we consider here are the ones used the most in our economic analysis.

2. 2 Graphs We will use a graph here because lots of information can be packed into one graph. The graph on the next screen is a general graph and is consistent in a general sense with the example we saw in the previous section of notes. In the graph, heights of curves mean one thing and areas of rectangles mean something else. Let’s go there next.

3. 3 Cost concepts in a graph Q unit costs $ MC ATC AVC Q1Q1 MC 1 AVC 1 ATC 1 a b

4. 4 Interpretation u I have picked Q 1 arbitrarily and have drawn a line from this Q up to the highest cost curve. u MC 1 is the MC of the this unit. u AVC 1 is the AVC of all the units. u ATC 1 is the ATC of all the units.

5. 5 Interpretation continued u Since TC = TFC + TVC, ATC = AFC + AVC or AFC = ATC - AVC. u So in the diagram, AFC 1 = ATC 1 - AVC 1. u Area a = AVC 1 times Q 1 = TVC 1. u Area b = (ATC 1 - AVC 1 ) times Q 1 = TFC 1.

6. 6 Interpretation continued u Area a + b =TVC 1 + TFC 1 = TC 1. u The concept of diminishing returns is the primary force driving costs in the short run. The rest of the ideas are definitions. The u - shape of the curves are due to the diminishing returns concept.