Ch. 8 Sec. 3

Ch. 8 Sec. 3 - chapter 8 Behind the Supply Curve: > Inputs...

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>> Behind the Supply Curve: Inputs and Costs Section 3: Short-Run Versus Long-Run Costs chapter 8 Up to this point, we have treated fixed cost as completely outside the control of a firm because we have focused on the short run. But as we noted earlier, all inputs are vari- able in the long run: this means that in the long run fixed cost may also be varied. In the long run, in other words, a firm’s fixed cost becomes a variable it can choose. For example, given time, Ben’s Boots can acquire additional boot-making machinery or dispose of some of its existing machinery. In this section, we will examine how a firm’s costs behave in the short run and in the long run. We will also see that the firm will choose its fixed cost in the long run based on the level of output it expects to produce. Let’s begin by supposing that Ben’s Boots is considering whether to acquire addi- tional boot-making machines. Acquiring additional machinery will affect its total cost in two ways. First, the firm will have to either rent or buy the additional machinery; either way, that will mean higher fixed cost in the short run. Second, if the workers have more equipment, they will be more productive: fewer workers will be needed to produce any given output, so variable cost for any given output level will be reduced. The table in Figure 8-10 shows how acquiring an additional machine affects costs. In our original example, we assumed that Ben’s Boots had a fixed cost of $108. The left half
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of the table shows variable cost as well as total cost and average total cost assuming a fixed cost of $108. The average total cost curve for this level of fixed cost is given by ATC 1 in Figure 8-10. Let’s compare that to a situation in which the firm buys an additional boot-making machine, doubling its fixed cost to $216 but reducing its variable cost at any given level of output. The right half of the table shows the firm’s variable cost, total cost, and average total cost with this higher level of fixed cost. The average total cost curve corresponding to $216 in fixed cost is given by 2 in Figure 8-10. 2 CHAPTER 8 SECTION 3: SHORT-RUN VERSUS LONG-RUN COSTS Figure 8-10 $250 200 150 100 50 Average total cost of pair Quantity of boots (pairs) 789 1 0 6 5 4 3 2 1 0 (High fixed cost) (Low fixed cost) At low output levels, low fixed cost yields lower average total cost. At high output levels, high fixed cost yields lower average total cost. ATC 2 ATC 1 Choosing the Level of Fixed Cost for Ben’s Boots There is a trade-off between higher fixed cost and lower variable cost for any given output level, and vice versa. 1 is the average total cost curve corresponding to a fixed cost of $108; it leads to high variable cost. 2 is the average total cost curve corresponding to a higher fixed cost of $216 but lower variable cost. At low output levels, fewer than 4 pairs of boots per day, 1 lies below 2 : average total cost is lower with only $108 in fixed cost. But as output goes up, average total cost is lower with the higher amount of fixed cost, $216: at more than 4 pairs of boots per day, 2 lies below 1 .
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This note was uploaded on 04/13/2010 for the course ECON 1110 taught by Professor Wissink during the Fall '06 term at Cornell.

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Ch. 8 Sec. 3 - chapter 8 Behind the Supply Curve: > Inputs...

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