key term - Short-Run Average Cost

Definition

Short-run average cost (SRAC) refers to the average cost of production in the short-run, which is the period of time where at least one factor of production is fixed. SRAC is a crucial concept in understanding a firm's cost structure and decision-making process in the short-run.

5 Must Know Facts For Your Next Test

1. The short-run average cost curve is typically U-shaped, reflecting the law of diminishing returns and the impact of fixed and variable costs.
2. As output increases, the short-run average cost curve first decreases due to economies of scale, then increases due to diseconomies of scale.
3. The point at which the short-run average cost curve is minimized represents the most efficient level of production in the short-run.
4. Changes in the prices of variable inputs, such as labor or raw materials, can shift the short-run average cost curve.
5. The relationship between short-run average cost and marginal cost is crucial in understanding a firm's profit-maximizing decisions in the short-run.

Review Questions

• Explain how the concept of short-run average cost is related to the law of diminishing returns.
  • The law of diminishing returns states that as additional units of a variable input (such as labor) are added to a fixed input (such as capital), the marginal product of the variable input will eventually decrease. This, in turn, leads to an increase in the short-run average cost as more of the variable input is required to produce each additional unit of output. The U-shaped short-run average cost curve reflects the interplay between economies of scale and the law of diminishing returns.
• Describe how changes in the prices of variable inputs can affect the short-run average cost curve.
  • The short-run average cost curve is influenced by the prices of variable inputs, such as labor and raw materials. If the prices of these inputs increase, the firm's total variable costs will rise, leading to an upward shift in the short-run average cost curve. Conversely, if the prices of variable inputs decrease, the short-run average cost curve will shift downward. These shifts in the SRAC curve can have significant implications for the firm's production decisions and profitability in the short-run.
• Analyze the relationship between short-run average cost and marginal cost, and explain how this relationship affects a firm's profit-maximizing decisions.
  • The relationship between short-run average cost and marginal cost is crucial in determining a firm's profit-maximizing level of output in the short-run. When marginal cost is below the short-run average cost, producing an additional unit of output will lower the average cost, thereby increasing the firm's profitability. Conversely, when marginal cost is above the short-run average cost, producing an additional unit will increase the average cost, reducing the firm's profitability. The profit-maximizing level of output occurs where marginal cost equals the market price, which corresponds to the point where the short-run average cost is minimized.

Related terms

Short-Run: The period of time where at least one factor of production is fixed, such as the size of a firm's capital stock or the number of production facilities.

Average Cost:

The total cost of production divided by the quantity of output produced, representing the cost per unit of output.

Marginal Cost:

The additional cost incurred by producing one more unit of output, which is a key factor in determining the shape of the short-run average cost curve.