EXTENT (HOW MUCH)

DECISION
CHAPTER 4
AVERAGE COST

AVERAGE COST – COST PER UNIT OF OUTPUT.

𝑇𝑂𝑇𝐴𝐿 𝐶𝑂𝑆𝑇 (𝑇𝐶)

AVERAGE TOTAL COST (ATC) = 𝑄𝑈𝐴𝑁𝑇𝐼𝑇𝑌 (𝑄)

𝑇𝑂𝑇𝐴𝐿 𝐹𝐼𝑋𝐸𝐷 𝐶𝑂𝑆𝑇 (𝑇𝐹𝐶)

AVERAGE FIXED COST (AFC) = 𝑄𝑈𝐴𝑁𝑇𝐼𝑇𝑌 (𝑄)

𝑇𝑂𝑇𝐴𝐿 𝑉𝐴𝑅𝐼𝐴𝐵𝐿𝐸 𝐶𝑂𝑆𝑇 (𝑇𝑉𝐶)

AVERAGE VARIABLE COST (AVC) =
𝑄𝑈𝐴𝑁𝑇𝐼𝑇𝑌 (𝑄)
MARGINAL ANALYSIS

MARGINAL COST – IS THE ADDITIONAL COST INCURRED BY PRODUCING AND

SELLING ONE MORE UNIT.

𝐶𝐻𝐴𝑁𝐺𝐸 𝐼𝑁 𝑇𝑂𝑇𝐴𝐿 𝐶𝑂𝑆𝑇 (Δ𝑇𝐶)

MARGINAL COST (MC) =
𝐶𝐻𝐴𝑁𝐺𝐸 𝐼𝑁 𝑄𝑈𝐴𝑁𝑇𝐼𝑇𝑌 (Δ𝑄)

𝐶𝐻𝐴𝑁𝐺𝐸 𝐼𝑁 𝑇𝑂𝑇𝐴𝐿 𝑉𝐴𝑅𝐼𝐴𝐵𝐿𝐸 𝐶𝑂𝑆𝑇 (Δ𝑇𝑉𝐶)

MARGINAL VARIABLE COST (MVC) =
𝐶𝐻𝐴𝑁𝐺𝐸 𝐼𝑁 𝑄𝑈𝐴𝑁𝑇𝐼𝑇𝑌 (Δ𝑄)

TOTAL FIXED COST (TFC) = CONSTANT; MC = MVC SINCE TOTAL VARIABLE

COST (TVC) IS THE ONLY COMPONENT THAT CAUSES TC TO CHANGE.
MARGINAL ANALYSIS

MARGINAL REVENUE – ADDITIONAL REVENUE GAINED FROM SELLING ONE

MORE UNIT.

TOTAL REVENUE (TR) = PRICE x QUANTITY

𝐶𝐻𝐴𝑁𝐺𝐸 𝐼𝑁 𝑇𝑂𝑇𝐴𝐿 𝑅𝐸𝑉𝐸𝑁𝑈𝐸 (Δ𝑇𝑅)

MARGINAL REVENUE (MR) =
𝐶𝐻𝐴𝑁𝐺𝐸 𝐼𝑁 𝑄𝑈𝐴𝑁𝑇𝐼𝑇𝑌 (Δ𝑄)

SELL MORE IF MR > MC; SELL LESS IF MR < MC; IF MR = MC, YOU ARE
SELLING THE RIGHT AMOUNT (MAXIMIZING PROFIT).
 TABLE 4.1
COST-OUTPUT RELATIONSHIP IN THE SHORT RUN

QTY TFC TVC TC AFC AVC ATC MC MR TR if TOTAL

PRICE = PROFIT
11.50
0 40 0 40 0 0 0 0 0 0 -40
1 40 5 45 40 5 45 5 11.50 11.50 -33.50
2 40 8 48 20 4 24 3 11.50 23 -25
3 40 11 51 13.33 3.67 17 3 11.50 34.50 -16.50
4 40 13 53 10 3.25 13.25 2 11.50 46 -7
5 40 16 56 8 3.2 11.2 3 11.50 57.50 1.50
6 40 20 60 6.67 3.33 10 4 11.50 69 9
7 40 27 67 5.71 3.86 9.57 7 11.50 80.50 13.50
8 40 35 75 5 4.38 9.38 8 11.50 92 17
9 40 44 84 4.44 4.89 9.33 9 11.50 103.50 19.50
10 40 55 95 4 5.5 9.5 11 11.50 115 20
11 40 68 108 3.64 6.18 9.82 13 11.50 126.5 18.50
12 40 83 123 3.33 6.92 10.25 15 11.50 138 15
INCENTIVE PAY

SHIRKING – SMALLER MARGINAL BENEFIT OF SELLING WITH LESS

EFFORT.

TO INDUCE HIGHER EFFORT, USE INCENTIVES THAT REDUCE

MARGINAL COSTS OR INCREASE MARGINAL BENEFITS. FIXED COST OR
BENEFITS DO NOT CHANGE EFFORT.