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Take–away of today’s lecture
Short-run and Long-run cost concepts
 Learning Outcome

1. Enabling the student to understand what is cost

and what all different cost structures are involved in
the process of production and how short run cost
varies from long run.
 Time to recall

1. What do you understand by cost and can u

differentiate between implicit cost and explicit
cost?

2. Suppose you are running a small kiosk, identify the

fixed and variable cost of that kiosk.
 COST OF PRODUCTION

SHORT RUN

A production period in which at least one

of the input is fixed*.

LONG RUN

A production period in which all the

inputs are variable**.
* A fixed input is an input which the quantity does not change
according to the amount of output. E.g. machinery
** A variable input is an input which the quantity varies according to
the amount of output. E.g. labour
 SHORT-RUN PRODUCTION COST
TOTAL COST (TC)

✓ The sum of cost of all inputs used to produce goods and services.
✓ Total cost (TC ) also defined as total fixed cost (TFC) plus
total variable cost (TVC).

TC = TFC + TVC

TOTAL FIXED COST (TFC) TOTAL VARIABLE COST (TVC)

✓ The cost of inputs that are ✓ The cost of inputs that changes
independent of output. with output.
✓ Examples: Factory, machinery ✓ Example: Raw materials, labours,
and etc. etc.
 AVERAGE TOTAL COST (ATC)
✓ The total cost per unit of output.
✓ The formula for average total cost (ATC) is the total cost (TC)
divided by the output (Q).

ATC = TC
Q

TC = TVC + TFC
AVERAGE FIXED COST (AFC)
Total fixed cost (TFC) divided by total output:
AFC = TFC
Q

AVERAGE VARIABLE COST (AVC)

Total variable cost (TVC) divided by total output:
AVC = TVC
Q
MARGINAL COST (MC)
The change in total cost that results from a change in output;
the extra cost incurred to produce another unit of output:
MC = TC
Q
 Costs in Short Run
Costs

• Fixed Costs
C TFC – Do not vary with output; e.g.
plant, machinery, building.

O
Quantity
 Variable Cost

COST

TVC

TOTAL VARIABLE COST (TVC)

The cost of inputs that changes with output.

QUANTITY
TC= TFC + TVC
 SHORT-RUN COST CURVES

TOTAL COST (TC)

COST
TC The sum of cost of all inputs used to produce goods
and services.
Also defined as TFC plus TVC

TVC TC = TVC + TFC

TOTAL VARIABLE COST (TVC)

The cost of inputs that changes with output.

TFC
TOTAL FIXED COST (TFC)
The cost of inputs that is independent of output.

QUANTITY
Polling question
Economic cost includes explicit cost and
a) implicit cost
b) social cost
c) fixed cost
d) money cost
 Total costs Average costs

(1) (2) (3) (4) (5) (6) (7) (8)

Quantity Total Total Total Average Average Average Marginal
(Q) fixed variable cost fixed cost variable total cost cost (MC)
cost cost (TC) (AFC) cost (AVC) (ATC)
(TFC) (TVC)

0 20 0

1 20 15

2 20 25

3 20 30

4 20 35

5 20 45
 Total costs Average costs

(1) (2) (3) (4) (5) (6) (7) (8)

Quantity Total Total Total Average Average Average Marginal
(Q) fixed variable cost fixed cost variable total cost cost (MC)
cost cost (TC) (AFC) cost (AVC) (ATC)
(TFC) (TVC) TC=TFC AFC = AVC = ATC = MC =
+TVC TFC/Q TVC/Q TC/Q TC/Q

(2)+(3) (2)/(1) (3)/ (1) (4)/(1) or (4) /(1)

(5)+(6)

0 20 0 20 - - - -

1 20 15 35 20 15 35 15

2 20 25 45 10 12.50 22.50 10

3 20 30 50 6.67 10 16.67 5

4 20 35 55 5 8.75 13.75 5

5 20 45 65 4 9 13 10
 MARGINAL COST (MC)
COST Change in total cost that results from a change in output
MC = TC
MC ATC Q

AVERAGE TOTAL COST (ATC)

Total cost per output

AVC ATC = TC ATC = AFC + AVC

Q

AVERAGE VARIABLE COST (AVC)

Total variable cost (TVC) divided by total output
AVC = TVC
Q

AVERAGE FIXED COST (AFC)

Total fixed cost (TFC) divided by total output

AFC = TFC
AFC Q

QUANTITY
 Average and Marginal Cost Functions
Contd…

AC/MC MC • AC curve is U shaped

• When both AFC and AVC fall, AC

AC also falls and when AVC rises AC
AVC starts increasing.

• When average costs decline, MC

lies below AC.

• When average costs are constant

AFC (at their minimum), MC equals AC.
O – MC passes through the lowest
Quantity
point of AC curves.
• When average costs rise, MC curve
lies above them.
 Why AC is ‘U’ shaped?

• Law of Variable proportions

• Shape of AVC and AFC
• Economies and Diseconomies of Scale
Polling question
• Average fixed cost is obtained by dividing
a) TC/Q
b) TFC/Q
c) TVC/Q
D) None
Long-run cost curve