ECON 1 (Chapter 11)

Firm's Marginal Cost and Average Total Cost Curves 3 General Principles

1) At the minimum-cost output, average total cost is equal to marginal cost 2) At output less than the minimum-cost output, marginal cost is less than average total cost and average total cost is falling 3) At output greater than the minimum-cost output, marginal cost is greater than average total cost and average total cost is rising

Why does the marginal cost curve slope upward?

Because there are diminishing returns to inputs in this example. As output increases, the marginal product of the variable input declines. This implies that more and more of the variable input must be used to produce each additional unity of output as the amount of output already produced rises. And since each unit of the variable input must be paid for, the additional cost per additional unit of output also rises.

average total cost AKA average cost

TC/Q

fixed input

an input whose quantity is fixed for a period of time and cannot be varied

In the long run, a firm's fixed cost

becomes a variable it can choose

marginal cost

change in total cost generated by one additional unit of output= change in total cost/change in quantity of output

variable cost

cost that depends on the quantity of output produced. Cost of the variable input

fixed cost

cost that does not depend on the quantity of output produced. Cost of fixed input

U-shaped average total cost

falls at low levels of output, then rises at higher levels

In long run, firms choose

fixed cost according to expected output. Higher fixed cost reduces average total cost when output is high. Lower fixed cost reduces average total cost when output is low

average fixed cost

fixed cost per unit of output

variable input

input whose quantity the firm can vary at any time

At low levels of output there are often increasing returns of the variable input due to the benefits of specialization,

making the marginal cost curve "swoosh"-shaped: initially sloping downward before sloping upward

In general, for each output level, there is some choice of fixed cost that

minimizes the firm's average total cost for that output level. So when the firm has a desired output level that it expects to maintain over time, it should choose the level of fixed cost optimal for that level-that is, the level of fixed cost that minimizes its average total cost

production funciton

relationship between the quantity of inputs a firm uses and the quantity of output it produces

total product curve

shows how quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input

total cost curve

shows how total cost depends on the quantity of output. FC+VC Becomes steeper as more output is produced due to diminishing returns to the variable input

long-run average total cost curve

shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output

Increasing output has 2 opposing effects on average total cost

spreading effect: the larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower average fixed cost diminishing returns effect: the larger the output, the greater the amount of variable input required to produce additional units, leading to higher average variable cost

total cost of producing a given quantity of output

sum of the fixed cost and the variable cost of producing that quantity of output

marginal product of an input

the additional quantity of output that is produced by using one more unit of that input

Flattening of the total product curve is also due to diminishing returns:

the marginal product on an input falls as more of that input is used if the quantities of other inputs are fixed. The flattening of the total product curve as output increases and the steepening of the total cost curve as output increases are just flip-sides of the same phenomenon. That is, as output increases, the marginal cost of output also increases because the marginal product of the variable input decreases.

minimum-cost output

the quantity of output of which average total cost is lowest-the bottom of the U-shaped average total cost curve

long run

time period in which all inputs can be varied

short run

time period in which at least one input is fixed

all marginal costs slopes

upward- the result of diminishing returns that make an additional unit of output more costly to produce than the one before. Average variable cost also slopes upward-again, due to diminishing returns-but is flatter than the marginal cost curve. This is because the higher cost of an additional unit of output is average across all units, not just the additional units, in the average variable cost measure. Meanwhile average fixed cost slopes downward because of the spreading effect

Diminishing returns

usually grow increasingly important as output rises. As a result, when output is large, the diminishing returns effect dominates the spreading effect, causing the average total cost curve to slope upward

average variable cost per unit of output

variable cost per unit of output, rises as output increases

At low levels of output, the spreading effect is ...

very powerful because even small increases in output cause large reductions in average fixed cost. So at low levels of output, the spreading effect dominates the diminishing returns effect and causes the average fixed cost is already quite small, so increasing output further has only a very small spreading effect

diminishing returns to an input

when an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input

increasing returns to scale

when long-run average total cost declines as output increases

decreasing returns to scale

when long-run average total cost increases as output increases

constant returns to scale

when long-run average total cost is constant as output increases