Costs of production

• Short-run


  One factor of production is fixed, therefore there are fixed costs.
• Long-run


  All costs are variable, meaning they can change.
• E.g. you can't move factories in the short-run (may have a fixed cost such as rent) but you can in the long-run (rent may change).
• The measure of the short-run varies with industry.
• Fixed costs


  Do not vary with output (indirect), e.g. rent and advertisement
• Variable costs


  Change with output (direct), e.g. cost of raw materials increases as output increases
• Total cost


  Cost to produce a given level of output; TC = TFC+TVC
• Average costs


  Costs per unit; AC= TC/quantity produced
• Marginal cost


  Cost of producing one extra unit of output.
• According to the law of diminishing returns, after a certain point, marginal cost rises as output increases.
• At one point, employing more resources will be less productive, which means the marginal output decreases per extra factors of production. Marginal cost starts to increase.
• At the MES point on the LRAC, economies of scale are fully utilised.
• LRAC curve

  • Initially, average cost falls because firms take advantage of economies of scale
  • Average costs are falling as output increases
  • After the optimum level of output (MES), where AC is at its lowest, AC rises due to diseconomies of scale.
• If factors units become more productive, firms can produce more output with a smaller input. This results in lower unit costs of production.
• As average costs per unit of one factor increases, e.g. labour, firms are likely to switch to cheaper (and generally more productive) factor inputs, e.g. capital.