Lecture 12 Short Run Cost Theory

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Lecture 12Short Run Cost Theory

• Original objective is to develop a theory of the
  firm from which a supply curve can be derived.
• Production theory identified a relationship
  between
• Q L
• Supply is a relationship between
• Q P
• Since P is measured in , its necessary to
  monetize L.

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• Monetize L by multiplying by
• wage (W)
• L x W TVC
• Total Variable Cost (TVC) total payment to the
  variable factors of production.
• Note W is constant because the market (not the
  firm) determines the prevailing wage.

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Adjusting the Graphs Orientation
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Adjusting the Graphs Orientation
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Monetize L by multiplying by wage (W)
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Opportunity cost of the fixed factor (K) must be
included.
Total Fixed Costs (TFC) total payments to the
fixed factors of production
_
_
TFC
K
x
PK
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Total Costs (TC) Total payment to all factors of
production.
TC
TVC TFC
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Average and Marginal Costs

• average fixed coats (AFC) fixed costs per unit
  of output produced.
• AFC TFC / Q
• average variable costs (AVC) variable costs per
  unit of output produced.
• AVC TVC / Q
• average total costs (ATC) total costs per unit
  of output produced.
• ATC TC / Q
• marginal costs (MC) change in costs resulting
  from a change in the level of production.
• MC ?TC / ?Q

?TVC / ?Q
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Graphing the Average Cost Curves
___
?
___
AFC TFC / Q


?
?
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Graphing the Average Cost Curves
? _at_ ?
____
AVC TVC / Q

?

? _at_ ?
? _at_ ?
____
?

then

? _at_ ?
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Graphing the Average Cost Curves
ATC TC / Q

AVC AFC
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Minimum AVC occurs at a smaller level of output
(Q) than minimum ATC
ATC AVC AFC
slope ATC slope AVC slope AFC
(0)
at min AVC
(lt0)
(lt0)


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Graphing the Marginal Cost Curve
Apply the total-marginal rule that marginal
slope of total

1. There is NO marginal associated with TFC because
   slope TFC
2. The marginal associated with TVC is U-shaped
   because slope TVC first
3. The marginal associated with TC is the same as
   that associated with TVC because

0
? _at_ ? rate
then ? _at_ ? rate
MTC MVC MFC MTC MVC 0 MTC MVC
? slope TC slope TVC

1. There is only ONE marginal cost curve (MC).

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Graphing the Marginal Cost Curve
Apply the average-marginal rule that
rising average ? marginal
gt
average
constant average ? marginal
average

falling average ? marginal
average
lt
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Production - Cost Duality Diminishing MP causes
AVC and MC to be U-shaped.
__
__
__
__
W x L
AVC TVC / Q
--------
W (L / Q)
W (L / TP)
W (1 / AP)
Q
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Production - Cost Duality Diminishing MP causes
AVC and MC to be U-shaped.
__
__
W x ?L
__
MC ?TVC / ?Q
---------
W (?L / ?Q)
W (?L / ?TP)
?Q
__
W (1 / MP)
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End Point Assignment

1. What is the difference between a variable cost
   and a fixed cost?
2. What is the difference between a total cost and
   an average cost?
3. Why are AVC, ATC and MC U-shaped?
4. Why is there only one marginal cost curve?
5. What is the production-cost duality?