1. 7 | Cost and Industry Structure

3. Fixed and Variable Costs Fixed costs are expenditures that do not change regardless of the level of production or factor usage, at least not in the short term. Whether you produce a lot or a little, the fixed costs are the same. Variable costs, on the other hand, are incurred in the act of producing—the more you produce, the greater the variable cost. Labor is treated as a variable cost, since producing a greater quantity of a good or service typically requires more workers or more work hours. Variable costs would also include raw materials. The Market Period, Short Run Period, and Long Run Period Nearly 120 years ago Alfred Marshall defined the periods of production and sale – in the market period, output could not change (since it had already been produced and was sent to market). During the market period the price could change, but not output, if there were a sudden change in demand. In the short run, labor could change, but the scale of the firm (its capital) could not. In the long run, everything could adjust freely, including the size of the plant (i.e. the amount of physical capital the firm uses). This categorization was later termed period analysis, and it is still used today, although dynamic economic analysis has moved on to use other tools and viewpoints. Setting things constant for a period can be convenient, but also misleading, in a fast changing world.

4. The Production Function

6. TC

7. The graphs to the left show clearly how to derive the Average and Marginal Cost curves from the Total Cost curve. As always, the marginal is the slope of the tangent line to the curve while the average is the slope of the ray from the origin to the curve.

8. Note: The Red and Blue rectangles to the left approximate the marginal cost for each level of output. Pay particular attention to the fact that the shape of the cost curve determines the shape of the marginal cost curve and that we expect that it falls over the initial units of output and then begins to rise steeply as output increases. This gives marginal cost a type of U-shape Q Q