Short Run Costs

11/11/21 1
Short Run Costs: Producing
with a fixed plant size.
 The production function shows the
relationship between a firm’s inputs and
its level of output (Q).
 Consider now the cost of each of these
inputs.
– Costs are: variable and fixed.

2
 Variable Cost
Workers

Raw Materials Plant

Workers
To Pro
duce m
a fixed ore wi
size p th
Raw Materials lant
Workers
Secretaries Interest
Rent Payments
Managers

Raw Materials Property Taxes Insurance

Fixed Cost
3
What are Fixed Rent
Secretaries Interest
Managers Payments
Property Taxes Insurance
Costs? Fixed Cost

 Are firm’s expenses that do not change with

the level of output (Q).
 These costs are the same when production is
high or when few or no units are produced.

Fixed costs can and do change:

A rent increase, an increase in taxes etc.

Common Mistake: “Fixed costs are

costs that do not change.” 4
Some labor costs are fixed.

 Most labor costs change with the

amount of output produced (are
variable), but some are fixed…
– A manager with a five-year contract is
considered a fixed cost, because the firm
pays him/her a fixed amount which does
not change with the firm’s output.

5
Graphing Costs

$ Costs
 Vertical Axis: Costs
 Horizontal Axis:
Quantity produced (Q)
The variables measured on
Quantity Produced (Q)
each axis are different
from what they were for

Quantity Produced (Q)

the Production Function:
Q was the vertical axis.

Labor (L)
6
 Fixed Costs Fixed Costs
Secretaries Interest
Rent
 Fixed Costs do not Managers Payments
Property Taxes Insurance
change with the level Fixed Cost
of output
 We show this by
drawing a horizontal
line. 40000
FC =40000 FC =40000 FC = 40000
when Q=0 when Q=500 when Q=10,000

Q=10,000
Q=0 Q=500
Q
What are Variable Costs?

 Costs that change with the amount

produced are variable.
 Examples:
– Most labor costs are variable.
• As output increases, more labor hours are
required and wage payments increase.
– Raw materials.

8
Total Costs

Total Costs include both

Fixed and Variable costs.
TC = FC + VC
11/11/21 ©2000Claudia Garcia-Szekely 9
Marginal Cost

The additional cost of producing an

additional unit of output (Q).
 When one more unit is produced, the
fixed cost does not change.
 ALL the change in total costs comes
from the change in the variable cost.

10
 Marginal Cost Formula
MC = TC/Q
= ΔFC/ΔQ + ΔVC/ΔQ
= ΔVC/ΔQ
 Because TC = VC, in the short run
 Marginal Costs are another way to look at
variable costs.

11
Marginal Cost
 Represent the extra cost of labor, raw
materials and other variable expenses incurred
when making an additional unit of output (Q).
 Are the additional, incremental costs
associated with “the last” unit produced.
 It is the slope of the TC and VC: the TC and
the VC have the exact same slope thus the
exact same shape.

12
From MP to MC
L Q MP VC MC
0 0 0

Decreases
Increases
1 5 5 50 10.00
2 15 10 100 5.00
3 30 15 150 3.33

MC
MP
4 50 20 200 2.50
5 67 17 250 2.94
6 82 15 300 3.33
7 95 13 350 3.85
MP decreases

MC Increases
8 107 12 400 4.17
9 117 10 450 5.00
10 125 8 500 6.25
11 131 6 550 8.33
12 136 5 600 10.00
 Assume that
From MP to MC labor is the
L Q MP VC MCONLY variable
0 0 0 cost

Decreases
Increases
1 5 5 50 10.00
2 15 10 100 5.00
3 30 15 150 3.33 Each

MC
MP
4 50 20 200 2.50 worker
5 67 17 250 2.94 costs
6 82 15 300 3.33 50/day
7 95 13 350 3.85
MP decreases

MC Increases
8 107 12 400 4.17
9 117 10 450 5.00
10 125 8 500 6.25
11 131 6 550 8.33
12 136 5 600 10.00
From MP to MC
L Q MP VC MC
0 0 0

Decreases
Increases
1 5 5 50 10.00
2 15 10 100 5.00
3 30 15 150 3.33

MC
MP
4 50 20 200 2.50
5 67 17 250 2.94
6 82 15 300 3.33
7 95 13 350 3.85
MP decreases

MC Increases
8 107 12 400 4.17
9 117 10 450 5.00
10 125 8 500 6.25
11 131 6 550 8.33
12 136 5 600 10.00
From MP to MC
L Q MP VC MC
0 0 0

Decreases
Increases
1 5 5 50 10.00
2 15 10 100 5.00
3 30 15 150 3.33

MC
MP
4 50 20 2.50= VC/Q
200 MC
5 67 17 250 2.94
6 82 15 300 3.33
7 95 13 350 3.85
MP decreases

MC Increases
8 107 12 400 4.17
9 117 10 450 5.00
10 125 8 500 6.25
11 131 6 550 8.33
12 136 5 600 10.00
From MP to MC
L Q MP VC MC
0 0 0
51 50 50/5=10

Increases
5 5 50 10.00
102 15 10 50 100 5.00
50/10=5
3 30 15 150 3.33
50/15=3.3

MP
4 50 20 200 2.50
50/20=2.5
5 67 17 50/17=2.9
250 2.94
6 82 15 300 50/15=3.3
3.33
7 95 13 50/13=3.8
350 3.85
MP decreases

MC Increases
8 107 12 400 MC = wage/MP
4.17
9 117 10 450 5.00
10 125 8 6.25= VC/Q
500 MC
11 131 6 550 8.33
12 136 5 600 10.00
From MP to MC MC = VC/Q
L Q MP VC MC
MC = wage/MP
Wage0is the 0same 0

Decreases
Increases
1 5 5 50 10.00
Increasing MP
2 15 10 100 5.00 =Decreasing
3 30 15 150 3.33 MC

MC
MP
4 50 20 200 2.50
5 67 17 250 2.94
6 82 15 300 3.33
7 95 13 350 3.85
MP decreases

MC Increases
8 107 12 400 4.17
9 117 10 450 5.00 =Increasing
10 125 8 500 6.25 MC
Wage11is the131
same 6 550 8.33
Decreasing
12 136MP 5 600 10.00
From MP to MC
L Q MP VC MC
0 0 0

Decreases
Increases
1 5 5 50 10.00
2 15 10 100 5.00
3 30 15 150 3.33

MC
MP
4 50 20 200 2.50
5 67 17 250 2.94
6 82 15 300 3.33
7 95 13 MP decreases 350 3.85

MC Increases
8 107 12 400 4.17
9 117 10 450 5.00
10 125 8 500 6.25
11 131 6 550 8.33
12 136 5 600 10.00
Relationship between MP and MC
MP = ΔQ/ΔL
1/MP = ΔL/ΔQ
MC = ΔVC/ΔQ
= ΔwL/ΔQ (w = wage rate of labour)
= w x ΔL/ΔQ (assuming w = constant)
= w x 1/MP

 Hence MP and MC are reciprocal to each

other. MC is the mirror image of MP

20
MP
Diminishing Returns to Labor

s
When the MPset
is at
in its Maximum

se

As
ea

th
cr

e
in

M
P
M

P
de
e
th

cr
As

e
as
es
Labor
L0
MC MP
MC
Th

es
e

as
M
C

re
de

c
in
cr

Diminishing
the MCReturns to Labor
C
ea

When is at its Minimum

M
se

set in
Th
s

Q0 Units of Output
 From VC to TC: add FC
L Q MP VC MC FC TC MC
0 0 0 50,000 50,000
1 5 5 50 10.00 50,000 10.00
2 15 10 100 5.00 50,000 5.00
3 30 15 150 3.33 50,000 3.33
4 50 20 200 2.50 50,000 2.50
5 Total
67 cost
17 of250 2.94 2.94
6 producing
82 15 zero300 3.33 3.33
7 units
95 = 50,000
13 350 3.85 TC
TC==FCFC++3.85
VC
VC
8 107 12 400 4.17 50,000 = FC +
4.17 VC
50,000 = FC + VC
9 Variable
117 10cost 450
of 5.00 50,000
50,000==FCFC++00
5.00
10 producing
125 8 zero500 6.25 FC
FC==50,0006.25
50,000
11 131
units 6= 0 550 8.33 8.33
12 136 5 600 10.00 10.00 22
L Q MP VC MC FC TC MC
0 0 0 50,000 50,000
1 5 5 50 10.00 50,000 50,050 10.00
2 15 10 100 5.00 50,000 50,100 5.00
3 30 15 150 3.33 50,000 50,150 3.33
4 50 20 200 2.50 50,000 50,200 2.50
5 67 17 250 2.94 50,000 50,250 2.94
6 82 15 300 3.33 50,000 50,300 3.33
7 95 13 350 3.85 50,000 50,350 3.85
8 107 12 400 4.17 50,000 50,400 4.17
9 117 10 450 5.00 50,000 50,450 5.00
10 125 8 500 6.25 50,000 50,500 6.25
Total Cost =
11 131 6 550 8.33 50,000 50,550 8.33
12
Fixed
136
Cost
5
+
600 10.00 50,000 50,600 10.00
Variable Cost
23
L Q MP VC MC FC TC
0 0 0 50,000 50,000
1 5 5 50 10.00 50,000 50,050
2 15 10 100 5.00 50,000 50,100
3 30 15 150 3.33 50,000 50,150
4 50 20 200 2.50 50,000 50,200
5 67 17 250 2.94 50,000 50,250
6 82 15 300 3.33 50,000 50,300
7 95 13 350 3.85 50,000 50,350
8 107 12 400 4.17 50,000 50,400
9 117 10 450 5.00 50,000 50,450
10 125 8 500 6.25 50,000 50,500
Total Cost =
11 131 6 550 8.33 50,000 50,550
Fixed
12 136
Cost 5
+ 600 10.00 50,000 50,600
Variable Cost
24
 MCVC/Q MCTC/Q
L Q MP VC MC FC TC MC
0 0   0   50000 50000  
1 5 5 50 10.00 50000 50050 10.00
2 15 10 100 5.00 50000 50100 5.00
3 30 15 150 3.33 50000 50150 3.33
4 50 20 200 2.50 50000 50200 2.50
5 MC can
67 be 17 250 2.94 50000 50250 2.94
6 calculated
82 15 300 3.33 50000 50300 3.33
7using the
95 VC 13 350 3.85 50000 50350 3.85
8 or the107TC 12 400 4.17 50000 50400 4.17
9 117 10 450 5.00 50000 50450 5.00
10 125 8 500 6.25 50000 50500 6.25
11 131
 VC
6 550
 TC
8.33 50000 50550 8.33
12 136 505 600 50
10.00 50000 50600 10.00
Marginal Cost
 Tells you how the Variable cost
changes as more output is produced
 Tells you how the Total cost
changes as more output is produced
 It is the slope of both Variable and
Total Cost

26
Variable Costs MC

Th tep

r s
S
e s

ge se
M ge

ar a
C t

t l re
ge nc
de sm
Variable Cost n

s Ci
cr al
i o
ct

ea ler

ep M
r
n

se
ge
u

St e
f

Th
s
ar
in g

tl
s

ge
ea
r

s
c

ep
In Q VC

St
r 0 0
a l l e 5 50
t s m
s ge 15 100

St ep 30 150
50 200
Starts at the Origin: 67 250
82 300
VC = 0 when Q=0 95 350
107 400
117 450
Output 125 500
131 550
136 600
 Total Costs TC MC

TSh

s
tee

seer
pMs

erag
VC

Cg

clra
edte

ient
Total Cost

scm

Cg
re

ps
M
als

ete
le

TSh
rs
Starts at FC: TC = FC when Q = 0
Starts at the Origin:
500 FC

Output
28
Per Unit Costs

Average Costs

29
Average (per unit) Costs

 TC = FC + VC
 To get per unit costs, divide by Q
(Units Produced)
 TC/Q = FC/Q + VC/Q
 ATC = AFC + AVC

30
 Fixed Costs
Fixed Costs

 Fixed Costs do not

change with the level
of output (Q)
 We show this by
drawing a horizontal
line. 40K
FC =40K FC = 40K
when Q=2 when Q=10

Q=2 Q Q=10
31
 Even
Even though
though FC
FC
remains
remains the
the same:
same: 40k
40k
Average Fixed Costs
FC = 40
Q=2 AFC = 40/2 = 20
Q=5 AFC = 40/5 = 8
Average Fixed Cost

Q = 10 AFC = 40/10 = 4
AFC =20
20 when Q=2
The Average
Fixed Cost
Decrease as
8 AFC = 4output increase
when Q=10
4
AFC
Q=2 Q=5 Q=10 32
Q
Variable Costs

Variable Cost on
cti
u n
g f
sin
ea
cr
In

Starts at the Origin: VC = 0 when Q=0

Output
33
Average Variable Costs
AVC Decreases at
the beginning
and then
AVC increases: “U”
Average Variable Cost

shape. WHY?
Because of increasing and
decreasing returns to labor
If MP increase, MC decrease
If MC decrease, AVC decrease
If MP decrease, MC increase
If MC increase, AVC increase
Q=2 Q=10
34
Q
 Total Costs
Total Cost

Starts at FC: TC = FC when Q = 0

40 FC

Output
35
Average (per unit) Costs

 TC = FC + VC
 To get per unit costs, divide by Q
(Units Produced)
 TC/Q = FC/Q + VC/Q
 ATC = AFC + AVC

36
 ATC =29
When Q =2
29
ATC

20
ATC = 19 AVC
when Q=10
AVC, AFC, ATC

19 AFC =20
15 when Q =2

9 AVC = 15
when Q=10

4
AVC =9 AFC
when Q=2 AFC = 4
when Q=10

Q=2 Q=10
37
 29
ATC
AVC
AFC
AVC, AFC, ATC

19
AFC
15 AFC AFC
9

Q=2 Q=10
 MC cuts the ATC and the AVC
at their MINIMUM points
ATC
MC
ATC,AVC, MC

AVC Min ATC

Min AVC
Min MC: Diminishing
returns to labor set in
Reach Minimum at different
Output levels 39
Average (Per Unit) Costs
ATC Follows the behavior of the AVC and the AFC

Decreases while both

AFC and AVC are
decreasing

Eventually increases as the

increase in AVC overtakes the
decrease in AFC.

ATC

40
 From Average Costs to Total
Costs
ATC = TC/Q TC =ATC x Q
AVC = VC/Q Rearrange as VC = AVC x Q
AFC = FC/Q FC = AFC x Q
Costs
ATC
MC

AVC

ATC
FC ATC x Q = TC
AVC
TC AVC x Q = VC
VC
AFC x Q = FC
Q AFC =ATC - AVC
42
 If MC < Average (Total or
Variable) Cost
Average Cost decreases
MC ATC
AT
C
fa
lli
ATC, MC

ATC ng

MC

Output
43
 If MC > Average (Total or
Variable) Cost
Average Cost increases
MC ATC

g
ATC, MC

MC i n
s
ri
TC
ATC A

Output
44
 If MC = Average (Total or
Variable) Cost
Average Cost is minimum
MC ATC
ATC, MC

ATC does not rise or fall

MC

ATC = MC
ATC is Minimum
ATC

Output
Relationship between AP and AC
AP = Q/L
1/AP = L/Q

AC = C/Q
= wL/Q (assuming L is the only factor of
production and w = constant)
= w x 1/AP

 AP and AC are mirror image of each other.

46
 MP is max
MP, AP
AP is max

AP
MP
L

MC, AC MC AC

AC is min

MC is min
Q