3.3.2 Costs

• Formula for Total Costs

  TC= FC + VC (Total fixed cost+Total variable cost)
• Relationship of Total Fixed Cost

  TFC remains constant regardless of the level of production
• Relationship of Variable Cost

  TVC varies with the level of production
• Formula for Average Total Cost

  ATC=TC/Q (Total cost/Quantity)

  
  

  ATC= TFC + TVC/Quantity of Output
• Formula for Average Fixed Cost

  AFC= FC/Q (Fixed cost/Quantity)
• Formula for Average Variable Cost

  AVC=VC/Q (Variable cost/Quantity)
• Formula for Marginal Cost

  MC=ΔTC/ΔQ (Change in Total cost/Change in Quantity)

  MC represents the additional cost incurred when producing one more unit of output
• Relationships between costs of production

  TC=FC+VC

  When MC is less than ATC,ATC is decreasing

  When MC is greater than ATC,ATC is increasing

  When MC is = to ATC, ATC is at its minimum point
• Derivation of short-run cost curves from the assumption of diminishing marginal productivity

  This assumption implies that as a firm increases its variable inputs (e.g labour) while keeping some inputs fixed (e.g machinery), the additional output generated by each additional unit of variable input will decrease
• Define Total Product

  Represents the total output or quantity produced

  TP usually increases as more inputs are used (e.g labour), however TP can fall when labour is increased when MP becomes negative
• Formula for Average Product (AP)

  AP=TP/L (output per worker)
• Define Marginal Product +Formula

  MP= change in TP/ change in L - MPP (Marginal Physical Product)

  whereas MRP (Marginal Revenue Product)= Additional Revenue from an extra worker - MP x MR or MP x Price
• Define Total Cost

  The cost incurred in the short run, which includes both fixed and variable costs.
• Define Variable Cost

  Those costs that do vary with a change in output e.g wages, raw materials
• Define Fixed Costs

  Those costs that do not vary with a change in output e.g rent, interest rates
• Relationship between Short-Run Cost Curves

  In the short run, firms have fixed inputs (like factory size), and they can only vary their variable inputs (like labour)

  
  

  Short-run average cost curves (SAC) show the cost of production under these fixed and variable constraints.
• Relationship between Long-Run Average Cost Curves

  In the long run, firms have the flexibility to adjust all inputs, including fixed inputs

  
  

  Long-run average cost curves (LAC) represent the cost of production when firms can choose the optimal combination of inputs and production techniques.
• The relationship between short-run and long-run average cost curves (2)

  In the long run, a firm aims to produce at the lowest possible average cost, so LAC represents the envelope of all possible SAC curves.

  
  

  The LAC curve is tangent to the lowest point of the SAC curves at each level of output.
• The relationship between short-run and long-run average cost curves (3)

  The long-run average cost curve is typically flatter and more efficient than any of the short-run average cost curves.

  
  

  This reflects the firm's ability to adapt and make optimal choices regarding input combinations and scale of production in the long run.
• ATC curve in SR

  • drop in ATC curve, increase in returns (AC decreases)
  • productivity increases, division of labour (specialisation)
  • rise in ATC curve, diminishing returns (AC increases)
  • productivity decreases, caused by a constraint of a fixed factor of production
• ATC curve in LR

  • drop in ATC curve, economies of scale, factor of production are variable, AC decreases
  • rise in ATC curve, diseconomies of scale (AC increases)