8.3 short run costs

• Labour Productivity and the Financial Crisis (2008-2009)

  Labour productivity in the UK stagnated after the 2008-2009 financial crisis for several reasons:

  • capital investement
  • labour hoarding
  • measurement issues
  • survival of inefficient companies
• Capital Investment (a): UK companies reduced investment in physical capital (machines, technology) after the financial crisis. This lack of investment meant that workers had to continue using older and less efficient machinery, which contributed to low productivity
• • Labour Hoarding (b): Companies retained workers despite a decrease in output. This "labour hoarding" resulted in lower average productivity as fewer goods were produced per worker.
• Survival of Inefficient Companies (d): Cheap funding allowed inefficient firms to survive, pulling down average productivity across the economy.
• SFC = short run fixed costs
• SVC = short run variable costs
• STC = short run total costs
• • Fixed Costs (SFC): Costs that don’t vary with output (e.g., rent, machinery).
  • Variable Costs (SVC): Costs that vary with output (e.g., labour costs).
  • Total Costs (STC): The sum of fixed and variable costs.
• Short-run total cost curve (STC): Total cost rises with output due to increasing variable costs.
• Short-run marginal cost curve (SMC): Shows the additional cost of producing one more unit of output. Initially, it decreases due to increasing productivity but rises after reaching a minimum because of diminishing returns.
• STC curve: Rises as production increases, indicating that more inputs are required to increase output.
• SMC curve:

  Initially decreases as productivity increases, then rises due to diminishing returns. This means the cost of producing additional units becomes more expensive after a certain point.
• SVC (Variable costs): Increases with output.
• SMC (Marginal Cost): Initially falls as output rises, but after a certain point, it begins to increase.
• Short-run marginal cost (SMC): The extra cost of producing one more unit of output. It first decreases with output and then rises due to diminishing returns.
• SMC decreases as output increases initially but rises as output continues increasing due to the need for additional inputs like labour.
• Average Total Cost (ATC): The total cost divided by the quantity of output.
• Average Variable Cost (AVC): Variable cost divided by output. It follows a U-shape because it decreases as output increases due to efficiency, but eventually rises due to diminishing returns.
• • Average Fixed Cost (AFC): Fixed costs per unit of output decrease as output increases because fixed costs are spread over more units.
• When SMC is less than ATC, ATC decreases.

  When SMC is greater than ATC, ATC increases.
• short run average total cost (SATC) = STC / Q
• Short run average variable costs (SAVC) = SVC / Q
• Short-run Marginal Cost (SMC): The change in total cost divided by the change in output.
• Amazon Go is an example of a firm with a large proportion of fixed costs (e.g., technology, R&D), and low marginal costs due to automation. By reducing labour costs (like cashiers), Amazon Go can lower its marginal cost, making each additional transaction more profitable.
• Short-run Marginal Cost (SMC): The change in total cost divided by the change in output.
• Short-run: In the short run, some inputs are fixed (like factory size or machinery), and some are variable (like labor or raw materials).
• Fixed costs (FC): Costs that do not change with the level of output, such as rent or salaries of permanent staff.
• Variable costs (VC): Costs that change with the level of output, like raw materials or wages of temporary workers.
• Total cost (TC): The sum of fixed and variable costs. TC=FC+VCTC = FC + VC
• • Marginal cost (MC): The extra cost of producing one more unit of output. This is critical in determining production levels.
• TC = FC + VC
• AFC = FC/Q
• AVC = VC/Q
• ATC = TC/Q
• MC = ∆TC/∆Q
• Marginal Cost (MC) Curve:

  • Initial Decline: At low output levels, MC decreases because of increasing returns to the variable factor (labour becomes more productive).
  • Rising Slope: As more units are produced, diminishing returns set in, meaning each additional unit of output requires proportionally more input, increasing the MC.
• Average Total Cost (ATC) Curve:

  • The ATC curve is U-shaped.
  • At low output levels, ATC decreases because fixed costs are spread over more units (falling AFC).
  • At higher output levels, ATC starts to rise as AVC increases due to diminishing returns.
• Relationship Between MC and ATC:

  • When MC is below ATC, producing additional units will lower the ATC (this is why the ATC curve is initially decreasing).
• • When MC is above ATC, producing additional units raises the ATC (this is why ATC starts to rise after a certain point).
• • MC intersects the ATC curve at the lowest point of ATC. This is a key point: the point where the MC curve crosses the ATC curve is the most efficient production level.