Supply: The Costs of Doing
Business
CHAPTER 8
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Firms and Production
The number of resources a firm uses and the
amount spent on selling activities depends on how
much they contribute to the value of the firm.
In general, the more the firm wants to supply the
more resources it must have.
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Output and Resources
Supply is the quantities of output that sellers are willing and
able to offer for sale at every price.
To determine how much to supply at any given price, sellers
must know how much it costs to supply each quantity.
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An Upward Sloping Supply
Curve
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Diminishing Marginal Returns
The law of diminishing marginal returns:
When successive equal amounts of a variable resource are combined
with a fixed amount of another resource, marginal increases in output
that can be attributed to each additional unit of the variable resource
will eventually decline.
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Diminishing Marginal Returns
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From Production to Costs
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Average Total Cost
Average total cost (ATC): the per unit cost derived by dividing total cost
by the quantity of output.
Plotting the cost on the vertical axis and quantity of output on the
horizontal axis generates the ATC curve.
total cost
ATC 
total output
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Average Total Cost
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Average Total Cost
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Marginal Cost
Marginal cost (MC): the change in cost caused by a change in output, derived
by dividing the change in total cost by the change in the quantity of output.
When marginal cost is greater than average cost, average cost rises -- ATC curve
slopes up.
When marginal cost is below ATC, then ATC falls -- ATC curve slopes down.
MC 
change in total cost
change in quantity of output
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Marginal Cost
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Average and Marginal Cost
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Definition of Costs
Total Costs (TC) -- the expenses a business has in supplying goods and/or
services.
Total Fixed Costs (TFC) -- payments to resources whose quantities can
not be changed during a fixed period of time – the short run.
Total Variable Costs (TVC) -- payments for additional resources used as
output increases.
Average Fixed Cost (AFC) -- the total fixed cost divided by total output.
Average Variable Cost (AVC) -- total variable cost divided by total output
Short-Run Average Total Cost (SRATC) -- the total cost of production
divided by the total quantity of output produced when at least one
resource is fixed
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Short vs. Long Run
The short run refers to any period of time during
which at least one resource cannot be changed.
In the long run, everything is variable – nothing is
fixed.
The most important difference between the short
run and the long run is that the law of diminishing
marginal returns does not apply when all resources
are variable.
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Economics of Scale
Scale means size.
Economies of scale: the decrease in per unit costs as the quantity of
production increases and all resources are variable
Diseconomies of scale: the increase in per unit costs as the quantity of
production increases and all resources are variable
Constant returns to scale: unit costs remain constant as the quantity of
production is increased and all resources are variable
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Economies of Scale and LongRun Cost Curves
In the long run, a firm has many sizes to choose from.
The short run requires that scale be fixed— only one or a
few resources can be changed.
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Long-Run or Planning Period
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Short-Run and Long-Run
Average-Cost Curves
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Long-Run Average Total Cost
Long-run average total cost (LRATC): the lowest-cost combination of
resources with which each level of output is produced when all
resources are variable.
The long-run average total cost curve gets its shape from economies
and diseconomies of scale.
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Shape of LRATC
If producing each unit of output becomes less costly there
are economies of scale.
If producing each unit of output becomes more costly
there are diseconomies of scale.
If unit costs remain constant as output rises there are
constant returns to scale.
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USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE
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Long-Run and Short-Run Cost
Curves (1)
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USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE
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Long-Run and Short-Run Cost
Curves (2)
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USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE
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Long-Run and Short-Run Cost
Curves (3)
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Minimum Efficient Scale
Most industries experience both economies and diseconomies of scale.
The minimum efficient scale (MES) is the minimum point of the longrun average-cost curve; the output level at which the cost per unit of
output is the lowest.
The MES varies considerably across industries.
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