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⚙️ Unit 3

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3.2 Short-Run Production Costs

jeanne stansak

caroline koffke

(editor)

⏱️ November 15, 2020

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In this section, we will address all the short-run costs associated with production. In the short-run, at least 1 resource is fixed, or cannot change. Fixed resources can include plant capacity, or the number of factories in operation.

Important Vocabulary

• Accounting costs—The explicit or "out of pocket" payments paid by firms to use resources during the production process.
• Economic costs—The sum of both the implicit costs (opportunity costs) and explicit costs of production. These costs include both the "out of pocket" payments paid by firms and the opportunity costs of using resources during the production process.
• Accounting profits—The profits earned by the firm when the revenue earned by the firm is greater than the explicit (accounting) costs of production (Total Revenue - Accounting Costs).
• Economic profits—The profits earned by the firm when the revenue earned by the firm is greater than the sum of the explicit (accounting) costs and the implicit (opportunity cost) costs of production (Total Revenue - Economic Costs).
• Implicit cost—Opportunity costs associated with decisions in the production of goods and services. Ex: If an individual gives up an annual salary to open a business, then that salary is seen as an implicit cost.
• Fixed Cost (FC)—The costs of fixed resources used during the production process. These costs do not change with the amount of output produced. Ex: rent, salaries, insurance.
• Variable Cost (VC)—The costs of variable resources used during the production process. These costs do change with the amount of output produced. The more output produced, the higher the variable costs are and vice versa. Ex: electricity, hourly wages, shipping costs.
• Total Cost (TC)—The sum of variable costs and fixed costs.
• Average Fixed Cost (AFC)—Fixed cost divided by the quantity of output
• Average Variable Cost (AVC)—Variable cost divided by the quantity of output.
• Average Total Cost (ATC)—Total cost divided by the quantity of output.
• Marginal Cost (MC)—The additional cost of producing each additional unit of output.

The table above shows the various cost curves of a particular firm at various levels of output. You can see at any level that Fixed Cost + Variable Cost = Total Cost. For example, at output level 6, the fixed costs are $200 and the variable costs are $45 which results in a total cost of $245. The table also shows how average fixed cost + average variable cost = average total cost. At output level 8, the AFC is $25 and the AVC is $9.75, and their sum gives you the ATC of $34.75. The final column in the table is the marginal cost (MC). Marginal cost is the change in total cost divided by the change in output, so going from an output of 2 to 3, the total cost changes from $220 to $224, and the change in output is 1 unit. This leads to a marginal cost of $4.

The diagram above shows what the FC, VC, and TC look like when graphed. The distance between the TC line and the VC line represents fixed costs. Fixed costs are constant and don't change with the production levels, but variable costs change with the level of production. Total costs change as variable costs change due to changes in output.

The diagram above shows how we graph marginal cost (MC), average fixed cost (AFC), average variable cost (AVC), and average total cost (ATC). MC always crosses both AVC and ATC at their lowest point. If fixed costs increase, then both the AFC and ATC would shift up and vice versa. If variable costs increase, then both AVC and ATC will shift upward and vice versa. The MC curve only shifts when variable costs change. It will shift upward for an increase in variable costs and downward for a decrease in variable costs.

This graph shows what happens when all the cost curves, except for AFC, shift upward due to changes in variable costs. The opposite would happen if there was a decrease in variable costs.