Chapter 13

U-Shaped Average Total Cost

The tug of war between average fixed cost and average variable cost generates the U-shape in average total cost.

The total-cost curve gets steeper as the amount produced rises, whereas the production function

Therefore, when the quantity produced is large, the total-cost curve is relatively steep. When the kitchen is crowded, producing an additional cookie requires a lot of additional labor and is thus very costly.

positive marginal cost curve

When Conrad produces a small quantity of coffee, he has few workers, and much of his equipment is not used. Because he can easily put these idle resources to use, the marginal product of an extra worker is large, and the marginal cost of an extra cup of coffee is small. By contrast, when Conrad produces a large quantity of coffee, his shop is crowded with workers, and most of his equipment is fully utilized Therefore, when the quantity of coffee produced is already high, the marginal product of an extra worker is low, and the marginal cost of an extra cup of coffee is large.

Average total cost reflects the shapes of

average fixed cost and average variable cost.

Whenever marginal cost is less than average total cost,

average total cost is falling.

Whenever marginal cost is greater than average total cost,

average total cost is rising.

the division of total costs between fixed and variable costs depends on

depends on the time horizon

fixed costs costs that do not vary with the quantity of output produced

variable costs costs that vary with the quantity of output produced

doesn't matter whether you compute marginal cost using total cost or variable cost

Marginal cost is the amount that total cost ( ) rises when the firm increases production by 1 unit of output ( ). Therefore, you can compute the marginal cost of the first unit of output in the following way:

marginal product

the increase in output that arises from an additional unit of input When the number of workers goes from 1 to 2, cookie production increases from 50 to 90, so the marginal product of the second worker is 40 cookies.

marginal cost

the increase in total cost that arises from an extra unit of production

economies of scale

the property whereby long-run average total cost falls as the quantity of output increases

the property whereby long-run average total cost falls as the quantity of output increases

the property whereby long-run average total cost rises as the quantity of output increases

constant returns to scale

the property whereby long-run average total cost stays the same as the quantity of output changes

diminishing marginal product

the property whereby the marginal product of an input declines as the quantity of the input increases

efficient scale

the quantity of output that minimizes average total cost The bottom of the U-shape of ATC

production function

the relationship between the quantity of inputs used to make a good and the quantity of output of that good he number of workers is on the horizontal axis, and the number of cookies produced is on the vertical axis.

The marginal-cost curve crosses the average-total-cost curve at its

At low levels of output, marginal cost is below average total cost, so average total cost is falling. But after the two curves cross, marginal cost rises above average total cost. As a result, average total cost must start to rise at this level of output. Hence, this point of intersection is the minimum of average total cost

explicit costs

input costs that require an outlay of money by the firm

An important implicit cost of almost every business is

is the opportunity cost of the financial capital that has been invested in the business. If Caroline had instead left this money in a savings account that pays an interest rate of 5 percent, she would have earned $15,000 per year. To own her cookie factory, therefore, Caroline has given up $15,000 a year in interest income. This forgone $15,000 is one of the implicit opportunity costs of Caroline's business. uppose now that Caroline did not have the entire $300,000 to buy the factory but, instead, used $100,000 of her own savings and borrowed $200,000 from a bank at an interest rate of 5 percent. Caroline's accountant, who only measures explicit costs, will now count the $10,000 interest paid on the bank loan every year as a cost because this amount of money now flows out of the firm.

negative profit

losses When a firm is making economic losses (that is, when economic profits are negative), the business owners are failing to earn enough revenue to cover all the costs of production. Unless conditions change, the firm owners will eventually close down the business and exit the industry.

The bottom of the U-shape occurs at the quantity that

minimizes average total cost. At the efficient scale, these two forces are balanced to yield the lowest average total cost.

Average variable cost usually rises as

output increases because of diminishing marginal product.

Average fixed cost always declines as

output rises because the fixed cost is getting spread over a larger number of units.

If a higher level of production allows workers to specialize in particular tasks, a firm will likely exhibit ________ of scale and ________ average total cost.

If a higher level of production allows workers to specialize in particular tasks, then the greater the level of output, the lower the average total cost will be. When long-run average total cost declines as output increases, there are said to be economies of scale, as average total cost falls with rising output.

At very low levels of output

average total cost is very high. average variable cost is low, average fixed cost is high because the fixed cost is spread over only a few units. As output increases, the fixed cost is spread over more units. Average fixed cost declines, rapidly at first and then more slowly. As a result, average total cost also declines

positive profit

stay in business

implicit costs

input costs that do not require an outlay of money by the firm