Let’s carry on from our introduction into microeconomics with a focus now on how firm’s costs vary with output in the short run (6months to 2 years).
Let’s Make an Important Assumption: Prices of inputs are assumed given (ie., firms can’t influence them)
Analyzing Short Run Cost Structure
Family of total costs concepts.
There are three important concepts of total cost for analyzing a firm’s short-run cost structure:
1. Total Fixed Cost (TFC) – sum of all costs of production which do not vary with the level of output (e.g., property taxes, insurance rates, etc.)
2. Total Variable Cost (TVC) – Sum of all costs of production which do vary with output (e.g., pay roll expenses, raw materials outlay, etc.)
3. Total Cost (TC) – Sum of all costs to the firm for any level of output. TC = TFC + TVC
Family of unit cost concepts.
There are four major unity cost concepts:
- 1. AFC = Fixed Cost/Quantity (Q) = FC/Q
- 2. AVC = Variable Cost/Quantity (Q) = VC/Q
- 3. ATC = Total cost/Quantity (Q) = TC/Q
- 4. MC = Change in total cost/Change in quantity = delta TC/ delta Q
Derivation of short-run cost functions
Important Assumption: Prices of inputs are assumed fixed
Intuition: Unit costs should be decreasing when the firm is productive and vice-versa.
Total Cost Principle: When variable input efficiency is rising TVC increases more slowly; when variable input efficiency is declining, TVC increases more rapidly.
Unit Cost Principle: When variable input efficiency is rising, AVC is falling; when variable input efficiency is declining, AVC is rising.
** Cost Graph – Quantity on x
TVC on y
Relationship Between Marginal Cost and Average Total Cost:
– MC = ATC at the minimum point of the ATC
– This point is called the “capacity”
– Capacity = Quantity that minimizes average total cost.
[tags]unit cost principle, cost principles, microeconomics, margin cost, total cost[/tags]