PRODUCTION COSTS: SHORT RUN AVERAGE COST CURVES
1.
Average fixed cost (AFC) :
a.
AFC decreases throughout the output (Q) range.
b.
If we extend the output range further to the right, AFC moves closer
and closer to the horizontal axis (Q - axis).
c.
2.
WHY? AFC = TC / Q ⇒ AFC ↓ as Q↑
↑.
Average variable costs (AVC) :
a.
The average variable cost curve is U - shaped.
b.
AVC first decreases, reaches a minimum, and the increases.
c.
WHY? Something you learned a little earlier known as the LAW
OF DIMINISHING RETURNS and the LAW OF INCREASING COSTS.
3.
Average total costs (ATC) :
a.
ATC has similar shape of AVC. However, it falls faster than AVC
in the beginning and rises slower after reaching its minimum point.
b.
WHY?
ATC = AFC + AVC
AFC and AVC both fall in the beginning, at some point
however, AVC begins to rise while AFC continues to fall.
When the increase in AVC OUTWEIGHS the decrease in AFC, the
ATC will begin to increase forming the familiar U - shaped curve.
4.
Marginal cost (MC) :
a.
This curve also decreases at first, reaches a minimum, then
increases.
b.
Relationship between MC and Average costs :
When MC < AVC AVC are decreasing
When MC > AVC AVC are increasing
c.
THINK !!
The only way for AVC to decrease (fall) is for the extra cost
of the next unit produced (MC) to be less than the AVC of all the
preceding units.
d.
MC intersects AVC and ATC at their minimum.
LONG RUN AVERAGE COST CURVE
1.
In the long run all costs are variable. Therefore, this curve is actually a
long run average variable cost curve, but since we know all costs are
variable in the long run, we just call it the LAC.
2.
The LAC is constructed form a series of short run average total cost
curves associated with a series of different output levels (Q).
3.
The LAC is the points which are tangent to the minimums of the short
run average total cost (SAC) curves associated with each output level.
4.
The diagram below should and the accompanying lecture should clear up
any confusion.
Assume you want to be a hog producer: Buy feeder pigs and sell
finished hogs.
ATC
LAC
SAC1
SAC3
SAC2
Q1
Q2
Q3
Quantity
5.
You can see that at output level Q2 that LAC is at its lowest point. This
would be the most economically efficient output level to achieve.
6.
Should you build your facilities as to achieve this level of output right
away? You need to answer several questions for yourself before decide.
a.
Can your production management skills handle that large of a facility
now?
b.
Can you manage the labor force required of that size facility?
c.
Are your abilities to schedule purchases of inputs up to par?
ex. Business planning skills.
d.
Are your marketing skills good enough to handle that volume of
production?
e.
Are your health management skills good enough to detect
disease outbreaks at their onset?
7.
From the stand point of a nursery business or landscaping business:
a.
Can your production management skills handle that large of a
business?
b.
Can you manage the labor force required : personnel management
skills, employee benefits program?
c.
Are your tax management skills adequate to handle that size
of business?
d.
Are your abilities to purchase inputs adequate? Is the input market large
enough to service your needs?
e.
Can the existing market for your commodity handle your production
volume? If the local market is not large enough, can you handle a
regional or national market?
This is why economic growth in an area is so important. As the
economy grows, markets grow and businesses expand attempting to
reach the production level associated with minimum LAC.
EXAMPLE :
A nursery business in Cary, NC, Mebane, NC. How big?
As Cary or Mebane grows your business can grow. This is why so
many businesses flock to an area which is growing in economic terms!