Econ 206(A) Tutorial 5
Costs and Revenue
Cost Concepts
1.
Fixed Costs. Do not vary with output (rent, plant
etc)
2.
Variable Costs. Vary with output (wages, raw
materials etc)
3.
Total Cost = Fixed Cost + Variable Cost
Totals, Averages and Marginals
• Total Cost (TC) = Average Cost (AC) * Quantity Produced (Q)
• Average Cost (AC) = Total Cost(TC)/Quantity(Q)
• Marginal Cost = The extra cost of producing one or more additional
units of output.
MC = ( ∆TC / ∆ Q ); or
MC = ( TCQ2 – TCQ1 )
Seminar Topic 1
1. Show How a Firms Short-run and
Long-run Cost Curve Can be Derived
From its Isoquant/Isocost Map
Output Expansion Path (long run)
Capital
(K)
The output expansion
path can be used to
derive long run costs!
C2 > C1 > C0
Output Expansion Path
b
c
Q2 > Q1 > Q0
a
Q2
Q1
Q0
C0
C1
C2
Labor (L)
Long Run Total Cost Curve
Cost
c
LTC
C2
b
C1
a
C0
Q0
Q1
Q2
Output (Q)
Output Expansion Path (short run)
Capital
(K)
In the short run, K is constant.
Diminishing MPL
C2 > C1 > C0
Output Expansion Path
Q2 > Q1 > Q0
a
b
c
Q1
Q2
Q0
C0
C1
C2
Labor (L)
Short Run Total Cost Curve
Cost
STC
c
C2
LTC
b
C1
a
C0
Q0
Q1
Q2
Output (Q)
Total Costs - Numerical
Output (Q) TFC (£)
TVC(£)
TC(£)
0
10
0
10
1
10
8
18
2
10
14
24
3
10
19
29
4
10
27
37
5
10
40
50
Total Costs = TFC+TVC
50
45
40
35
Cost
30
TFC (£)
25
TVC(£)
TC(£)
20
15
10
5
0
1
2
3
4
Quantity
5
6
Average and Marginal Costs
Output (Q) TC (£)
AC(£)
MC(£)
0
10
1
18
18
8
2
24
12
6
3
29
9.67
5
4
37
9.25
8
5
50
10
13
Seminar Topic 2
• Distinguish Between Internal and
External Economies/Diseconomies of
Scale.
Economies of scale
• Internal:
– Decreases in the cost of production (increase in
productivity) as output (q) of firm increases.
• External:
– Decreases in cost of production (increase in
productivity) as output (q) of industry increases.
– Examples:
• Improved transport and communication links.
• Training and education becomes tailored to the industry
(i.e. improved quality workers).
• Development of support firms and industries.
Revenue
• Total Revenue (TR ) = Quantity sold
times price; P x Q
• Average Revenue (AR) = TR/Q; (in
perfect competition this is P.)
• Marginal Revenue (MR) = MR = ( ∆TR /
∆ Q ).
Revenue
Q
TR
AR
MR
1
8
8
8
2
15
7.5
7
3
21
7
6
4
26
6.5
5
5
30
6
4
Seminar Topic 3
• Explain Why Marginal Costs Must Equal
Marginal Revenue for Profit
Maximisation.
Profit Maximisation
• Profit (P )= TR – TC
• Largest when MR=MC.
• Intuition:
– If MC>MR then TC is increasing quicker than TR.
Hence profit is decreasing.
– If MR>MC then an increase in Q will increase TR
more than TC. Hence profit could be increased by
producing more.
Profit Maximisation Rule –
Numerical Example
Q
MR
MC
TR
TC
Profit
1
8
6
8
6
2
2
7
6
15
12
3
3
6
5
21
17
4
4
5
6
26
23
3
5
4
7
30
30
0
Profit Maximisation Rule –
Numerical Example (slight variant MC=MR)
Q
MR
MC
TR
TC
Profit
1
8
6
8
6
2
2
7
6
15
12
3
3
5
5
20
17
3
4
5
6
25
23
2
5
4
7
29
30
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