amount of money you spend on labor will increase if you want to produce more) • Total cost is equal to fixed cost plus variable cost Average and Marginal Cost • Definition of average total cost (ATC): total cost divided by the quantity of output • Definition of average fixed costs (AFC): total fixed costs divided by the quantity of output • Definition of average variable cost (AVC): total variable costs divided by the quantity of output • Definition of marginal cost: the increase in total cost that arises from an extra unit of production • Average total cost tells us the cost of a typical unit of output and marginal cost tells us the cost of one more additional unit of output
Cost Curves • Rising marginal cost Ø This occurs because of diminishing marginal product Ø At a low level of output, there are few workers and a lot of idle equipment. But as output increases, the coffee shop (for example) gets crowded and the cost of producing another unit of output becomes high • U-shaped average total cost Ø Average total cost is the sum of average fixed cost and average variable cost Ø Definition of efficient scale: the quantity of output that minimizes average total cost, AKA the minimum of the ATC curve • Relationship between marginal cost and average total cost and average variable cost Ø The MC curve intersects the ATC curve at the minimum of the ATC curve Ø The MC curve also intersects the AVC curve at the minimum of the AVC curve
Competitive Markets • Definition of competitive market : a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker • There are three characteristics of a competitive market (sometimes called a perfectly competitive market): Ø There are many buyers and sellers Ø The goods offered by the sellers are largely the same Ø Firms can freely enter or exit the market • Total Revenue = Price x Quantity • Average Revenue = Total Revenue ÷ Quantity Ø Average revenue is always equal to the price • Marginal Revenue = Change in Total Revenue ÷ Change in Quantity • Marginal revenue is equal to the price only for firms that operate in perfectly competitive markets
Profit Maximization Q Total Revenue Total Cost Profit Marginal Revenue Marginal Cost Change in Profit 0 $0 $3 $-3 ---- ---- ---- 1 6 5 1 $6 $2 $4 2 12 8 4 6 3 3 3 18 12 6 6 4 2 4 24 17 7 6 5 1 5 30 23 7 6 6 0 6 36 30 6 6 7 -1 7 42 38 4 6 8 -2 8 48 47 1 6 9 -3 • In this example, profit is maximized if the farm produces four or five gallons of milk (see the fourth column) • The profit-maximizing quantity can also be found by comparing marginal revenue and marginal cost • As long as marginal revenue exceeds marginal cost, increasing output will raise profit • If marginal revenue is less than marginal cost, the firm can increase profit by decreasing output (AKA by producing less) • The profit-maximizing quantity occurs where marginal revenue is equal to marginal cost Ø In this example, this occurs at Q = 6
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