4 - Chapter 8 Decisions Facing Firms Decisions How much...

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1 07/09/07 Economics 1 Lecture 4 Chapter 8 Short-Run Costs and Output Decisions 07/09/07 Economics 1 Lecture 4 Decisions Facing Firms • Decisions – How much output to supply – Which production technology to use – The quantity of each input to demand are based on… • Information – The price of output – Techniques of production available – The price of inputs – The prices of related outputs 07/09/07 Economics 1 Lecture 4 Costs in the Short Run • The short run is a period of time for which two conditions hold: 1. The firm is operating under a fixed scale (fixed factor) of production, and 2. Firms can neither enter nor exit an industry. 07/09/07 Economics 1 Lecture 4 Costs in the Short Run Fixed cost is any cost that does not depend on the firm’s level of output. These costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run. Variable cost is a cost that depends on the level of production chosen. TC TFC TVC = + Total Cost = Total Fixed + Total Variable Cost Cost 07/09/07 Economics 1 Lecture 4 Fixed Cost Total fixed costs (TFC) or overhead refers to the total of all costs that do not change with output, even if output is zero. Average fixed cost (AFC) is the total fixed cost ( TFC ) divided by the number of units of output ( q ): AFC TFC q = 07/09/07 Economics 1 Lecture 4 Short-Run Fixed Cost (Total and Average) of a Hypothetical Firm 250 1,000 4 200 1,000 5 333 1,000 3 (2) TFC (3) AFC (TFC/q) 500 1,000 2 1,000 1,000 1 $ -- $1,000 0 (1) q As output increases, total fixed cost remains constant and average fixed cost declines.
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2 07/09/07 Economics 1 Lecture 4 Variable Costs The total variable cost curve is a graph that shows the relationship between total variable cost and the level of a firm’s output. The total variable cost is derived from production requirements and input prices. The relationship between total variable cost and quantity can take on many different forms. 07/09/07 Economics 1 Lecture 4 Marginal Cost ( MC ) Marginal cost (MC) is the increase in total cost that results from producing one more unit of output. Marginal cost reflects changes in variable costs. 6 24 3 TOTAL VARIABLE COSTS ($) MARGINAL COSTS ($) 8 18 2 10 10 1 0 0 0 UNITS OF OUTPUT 07/09/07 Economics 1 Lecture 4 The Shape of the Marginal Cost Curve in the Short Run In the short run every firm is constrained by some fixed input that: 1. leads to diminishing returns to variable inputs, and 2. limits its capacity to produce. 07/09/07 Economics 1 Lecture 4 Graphing Total Variable Costs and Marginal Costs Total variable cost always increases with output. The marginal cost curve shows how total variable cost changes. 07/09/07 Economics 1 Lecture 4 Average Variable Cost ( AVC ) Average variable cost (AVC) is the total variable cost divided by the number of units of output.
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