L7 and L8

• Short Run


  A time period where the firm is unable to vary all of its factors of production; at least one of the factor of production is fixed. Output can only be increased by using more variable factors.
• Long Run


  A time period where the firm is able to vary all its factor of production. Examples: Machinery
• Fixed costs


  Expenses that do not vary directly with the level of output i.e. independent of the level of production. Examples: Rent, machinery, building etc.
• Variable costs


  Costs that vary directly with output. Examples: Wages, materials used in production etc.
• Total Costs

  Total Fixed Cost (TFC) + Total Variable Cost (TVC)
• Short run Production Concepts

  • Average Fixed Cost (AFC)
  • Average Variable Cost (AVC)
  • Average Total Cost (ATC/AC)
  • Marginal Cost (MC)
• Average Fixed Cost (AFC)

  Fixed cost per unit of output
• Average Variable Cost (AVC)

  Variable cost per unit of output
• Average Total Cost (ATC/AC)


  Cost per unit of output
• Marginal Cost (MC)


  The change in total cost that comes from producing one additional unit of output. The purpose of analysing marginal cost is to understand how total costs changes as output increases.
• AVC is at minimum point, after they meet AVC continue to go up as long variable factors are input you will incur variable cost
• Average Total Cost (AC)


  Cost per unit of output = AFC + AVC
• Marginal Cost = (Change in Total Cost) / (Change in Quantity)
• When MC is less than AC, AC will decrease as output increases
• When MC is more than AC, AC will increase as output increases
• MC cuts AC at its minimum point
• Similarly, MC cuts AVC at its minimum point
• Marginal Cost increases, Marginal Product decrease
• A firm's MC is inversely related to its MP as they are linked by the input (labour) used in the production of the output, which translates to the cost of production.
• If MP rises, MC falls. MC reaches the minimum point when MP is at its maximum.
• LDMR sets in after minimum point of MC
• Similarly, a firm's AVC is inversely related to its AP as they are linked by the input (labour) used in the production of the output, which translates to the cost of production.
• If AP rises, AVC falls. AVC reaches the minimum point when AP is at its maximum.
• In summary, a firm's MC and AVC are inversely related to its MP and AP respectively as they are linked by the input (labour) used in the production of the output, which translates to the cost of production.
• The short run curves will come together to form the Long Run Average Cost curve (LRAC)
• A firm has a set of short-run average cost curves (SRACs); each SRAC is associated to a fixed factor of production such as plant size (e.g. SRAC1 only one plant, SRAC2 two plants etc.)
• Due to diminishing marginal returns, the short-run average cost will eventually be driven up as output increases. The firm will need to expand its plant size to achieve lower costs.
• Short run


  Factors of production can be either variable or fixed
• Law of diminishing marginal returns


  At some point, as more units of a variable input are added, the marginal product will start to decrease and marginal cost to increase
• Long run


  Firm is able to vary ALL factor inputs
• Returns to scale


  The change in output of a firm or industry resulting from a proportionate increase in all inputs
• Economies of scale


  The cost advantage that arises with increased output of a product
• Diseconomies of scale


  The cost disadvantage that arises with increased output of a product
• Economies and diseconomies of scale


  Relate directly to the costs of production
• Returns to scale


  Considers by how much the output increases when the inputs to production are scaled up, without considering changes in the costs of these inputs
• Short run

  • Variable factors
  • Fixed factors
  • Total fixed cost
  • Average fixed cost
  • Law of diminishing marginal returns
  • Total variable cost
  • Total cost
  • Average variable cost
  • Average total cost
  • Marginal cost
• Long run

  • Variable factors
  • Economies of scale (internal and external)
  • Diseconomies of scale (internal and external)
  • Returns to scale (increasing, decreasing, constant)
  • Long-run average cost
• Short run


  Period during which changes in certain factors of production are not possible
• Long run


  Period during which all factors of production can be varied
• There is no definite time-frame for short run and long run. It depends on when you can actually vary the fixed factor - renew rental lease or buy new equipment