3.3.2 Costs

• Short run:


  At least one factor of production is fixed (usually capital). This means that a business can only vary the other factors of production (labour/enterprise/land).
• Long run:


  All factors of production are variable.
• Total product (AKA total physical product):


  The total number of units produced by a firm.
• Marginal product (AKA marginal physical product):

  (w/ formula)

  The addition to total product when an additional input is employed.

  Marginal product = ∆ in total product/∆ in inputs
• Law of diminishing marginal returns:


  When increasing amounts of a variable factor (e.g. labour) are combined with a fixed factor (e.g. capital), the marginal product of the variable factor will decline.

  As the law of diminishing marginal returns requires only one factor to be fixed, it only applies in the short run.
• Fixed costs:


  Do not directly vary with output, e.g. rent.
• Variable costs:


  Vary directly with output, e.g. raw materials.

  This distinction is only relevant in the SR. In the LR, all factors are variable and therefore all costs are variable.
• Total cost (TC):


  The total cost of producing a given quantity of output.
• Total fixed cost (TFC):


  The total of all fixed costs. This remains constant regardless of output.
• Total variable cost (TVC):


  The total of all variable costs. This increases as output increase.
• Average costs (AC) formula:


  AC = TC/Q
• Average variable cost (AVC) formula:


  AVC = TVC/Q
• Average fixed cost (AFC) formula:


  AFC = TFC/Q
• Marginal cost (MC):


  The cost of producing an extra unit of output.
• Marginal cost (MC) formula:


  MC = ∆TC/∆Q
• Relationship between the law of diminishing returns and SR costs?

  Law of diminishing marginal returns -> decreasing marginal product -> more workers have to be employed to produce an extra unit of output -> higher marginal cost.