Cost Curve Model
Chapter 13 completion
Costs of Production
• Fixed costs - do not change with quantity of output
• Variable costs - ↑ with quantity of output
• Marginal cost ∆ total cost to make 1 extra unit
Fixed Costs + Variable Costs = Total Costs
Shape of MC Curve
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a
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Shape of MC curve is determined by
shape of MP Curve
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If MP ↑ => MC ↓
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a
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If MP ↓ => MC ↑
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MC
Cost Curve Model
Cost Curves
Model:
• uses average cost curves:
• uses economic costs
ATC = TC / Qty produced
AVC = TVC / Qty produced
AFC = TFC / Qty produced
Using Average Cost Curves
MC hits both ATC & AVC at their minimum
Costs
•When MC < ATC => average total cost is falling
$3.00
•When MC > ATC => average total cost is rising
2.50
MC
2.00
ATC is U-shaped
Due to high fixed costs
1.50
ATC
AVC
1.00
AFC always declines:
0.50
AFC
0
2
4
6
8
10
12
Fixed Costs spread over
more output
14
Quantity of Output
There are several formulas to calculate economic profit:
1) Profit = TR – TC
Cost Curves
2) Profit = (Price – ATC) X Qty
(most useful formula)
Market Price = P1
If P1 > ATC => Economic Profit
If P1 < ATC => Economic Loss
Economies of Scale
Price
• Economies of scale = Qty ↑ => ATC ↓
MC
ATC
– ATC falls as output increases
– Allows for specialization of workers
– Leads to more productivity per worker
• Diseconomies of scale = Qty ↑ => ATC ↑
– ATC rises as output increases
0
– coordination problems eventually arise as firms grow in size
• Constant returns to scale– Qty ↑ => ATC stays the same
Quantity
Practice Test
Short Run vs. Long Run Costs
• Costs depends on the time horizon considered
– In the short run, some costs are fixed
– In the long run, all fixed costs become variable costs
– Why: Firms have time to change both plant size & labor force
• Therefore, long-run cost curves differ from short-run
cost curves
Long Run ATC
Average
Total
Cost
Note! => The “term” economies of scale applies
only to long run cost curves
LRATC
$12,000
10,000
Economies
of
scale
0
Constant
returns to
scale
1,000 1,200
Diseconomies
of
scale
Quantity of
Cars per Day
Long Run vs. Short Run ATC
• LRATC is always below or on short run ATC curve
– you can be more efficient in long run!
Average
Total
Cost
Short run ATC
small factory
Short run ATC
medium factory
Short run ATC
large factory
LRATC
$12,000
10,000
Economies
of
scale
0
Constant
returns to
scale
1,000 1,200
Diseconomies
of
scale
Quantity of
Cars per Day