costs and economies of scale

• Short-run


  A period of time when there is at least one fixed factor of production
• The short-run is not defined in terms of six months or one year, it is defined in terms of the variability of factors of production</b>
• Factors of production in the short-run


  • Land
  • Capital
• In the long-run, all factors of production are variable
• Explicit costs


  Costs that require actual payment
• Implicit costs


  Opportunity cost, the profit a business could have made doing their next best alternative
• Explicit costs


  • Fixed costs
  • Variable costs
• Fixed costs


  Costs that do not vary with output
• Variable costs


  Costs that vary with output
• Total fixed costs


  Constant, does not vary with output
• Average fixed cost


  • Downward sloping, not affected by the law of diminishing returns
• Average variable cost


  Shaped due to the law of diminishing returns
• Calculating average variable cost

  1. Total variable cost / Quantity

  2. Average cost - Average fixed cost
• As labour productivity increases


  Average variable cost decreases
• When diminishing returns kick in

  Average variable cost starts to increase
• Total fixed cost and average fixed cost are the only two short-run cost curves not affected by the law of diminishing returns
• Marginal cost curve


  The shape of the marginal cost curve for a firm operating in the short-run
• The shape of the marginal cost and average cost curves


  Is due to the law of diminishing marginal returns
• Illustrating the law of diminishing returns

  1. Increasing labor productivity

  2. Increasing marginal product

  3. Diminishing returns kick in

  4. Labor productivity decreases

  5. Marginal product decreases

  6. Fixed factors of production become a constraint on production
• Marginal product increases


  Marginal cost decreases
• Marginal product decreases


  Marginal cost increases
• Marginal cost and average cost are the mirror reflections of marginal product and average product
• Marginal cost is what you want to break up to illustrate the law of diminishing returns and why the marginal cost curve is shaped the way it is
• The average cost curve also follows the same logic as the marginal cost curve in relation to the law of diminishing returns
• Average costs


  Costs per unit of output
• Marginal costs


  Additional cost of producing one more unit
• Drawing the three cost curves


  1. Total fixed cost

  2. Total variable cost

  3. Total cost
• Total fixed cost


  Costs that do not vary with output, constant over a range of output
• The total fixed cost curve is a horizontal line
• Total variable cost


  Costs that vary with output
• The shape of the total variable cost curve


  Is influenced by the law of diminishing marginal returns
• The shape of the total variable cost curve


  1. Initially increases at a decreasing rate as output increases

  2. Then increases at an increasing rate as diminishing returns set in
• Wages are the only variable cost in the short run for a given firm
• Adding a variable factor of production (labor) to fixed factors

  Initially increases total output, then output starts to fall due to diminishing returns
• Initially hiring workers


  Variable costs (wages) are high but productivity gains mean output increases faster than costs
• As more workers are hired

  Diminishing returns set in, productivity falls, and costs increase faster than output
• Total cost


  Total fixed cost plus total variable cost
• The total cost curve follows the shape of the total variable cost curve, just shifted up by the amount of total fixed cost
• Economies of scale


  A reduction in long-run average cost as output increases
• Long-run average cost curve is falling

  Firm is experiencing increasing returns to scale