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Chapter 7
Consider this short-run cost data for a firm.• Can you fill in the missing columns? And get all the curves?
workers TP TVC AVC MC MP TFC TC AFC ATC
0 0 $0 $600
1 20 $400 $600
2 44 $800 $600
3 75 $1,200 $600
4 102 $1,600 $600
5 123 $2,000 $600
6 137 $2,400 $600
7 146 $2,800 $600
8 150 $3,200 $600
9 152 $3,600 $600
10 152 $4,000 $600
TVC
$0$500
$1,000$1,500$2,000$2,500$3,000$3,500$4,000$4,500
0 50 100 150 200
PRODUCTS
COSTS
TVC
TVC/TFC
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
$4,500
0 50 100 150 200
TP
COSTS TVC
TFC
TCworkers TP TVC TFC TC
0 0 $0 $600 $6001 20 $400 $600 $1,0002 44 $800 $600 $1,4003 75 $1,200 $600 $1,8004 102 $1,600 $600 $2,2005 123 $2,000 $600 $2,6006 137 $2,400 $600 $3,0007 146 $2,800 $600 $3,4008 150 $3,200 $600 $3,8009 152 $3,600 $600 $4,200
10 152 $4,000 $600 $4,600
TVC
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
$4,500
$5,000
0 20 40 60 80 100 120 140 160
TP
COSTS
TVC
TFC
TC
TFC
TC
• TC=TVC+TFC• TFC is constant at $600 and TC will be parallel to
TVC, but $600 greater at all levels of TP.• The shapes of TC and TVC curves are determined
by diminishing marginal returns.– TVC increases as TP increases, however the TVC curve is
not a straight line but gets steeper as TP increases. Why?– The next worker hired generates less TP than before while
the cost remains the same, there fore the same increase in TP, TVC increases more.
MC of each unit of Product
• (TC2-TC1)/(TP2-TP1)
MC of each unit of ProductTP TVC TFC TC MC
0 $0 $600 $600 -----
20 $400 $600 $1,000 $20
44 $800 $600 $1,400 $17
75 $1,200 $600 $1,800 $13
102 $1,600 $600 $2,200 $15
123 $2,000 $600 $2,600 $19
137 $2,400 $600 $3,000 $29
146 $2,800 $600 $3,400 $44
150 $3,200 $600 $3,800 $100
152 $3,600 $600 $4,200 $200
152 $4,000 $600 $4,600 ------
MC
0
5
10
15
20
25
30
35
40
45
50
0 20 40 60 80 100 120 140 160
TP
COSTS
MC
Minimum MC
MC & MP
• MP=TP2-TP1
MC & MPTP TVC TFC TC MC MP
0 $0 $600 $600
20 $400 $600 $1,000 $20 20
44 $800 $600 $1,400 $17 24
75 $1,200 $600 $1,800 $13 31
102 $1,600 $600 $2,200 $15 27
123 $2,000 $600 $2,600 $19 21
137 $2,400 $600 $3,000 $29 14
146 $2,800 $600 $3,400 $44 9
150 $3,200 $600 $3,800 $100 4
152 $3,600 $600 $4,200 $200 2
152 $4,000 $600 $4,600 0
MP
0
5
10
15
20
25
30
35
0 20 40 60 80 100 120 140 160
TP
MP MP
MC & MP
MP
0
5
10
15
20
25
30
35
0 20 40 60 80 100 120 140 160
TP
MP MP
•Clearly, as MP initially rises MC falls; MC reaches it’s minimum when MP at it’s maximum; MC rises as MP declines.•MC is a mirror image of MP•MC is determined by diminishing marginal returns.
MC
0
5
10
15
20
25
30
35
40
45
50
0 20 40 60 80 100 120 140 160
TP
COST
S
MC
AC
qTFCAFC
qTVCAVC
qTC
qTVCTFCqTVC
qTFC
AVCAFCATC
AFC• TP TVC TFC TC MC MP AFC• 0 $0 $600 $600 • 20 $400 $600 $1,000 $20 20 30• 44 $800 $600 $1,400 $17 24 13.63636• 75 $1,200 $600 $1,800 $13 31 8• 102 $1,600 $600 $2,200 $15 27 5.882353• 123 $2,000 $600 $2,600 $19 21 4.878049• 137 $2,400 $600 $3,000 $29 14 4.379562• 146 $2,800 $600 $3,400 $44 9 4.109589• 150 $3,200 $600 $3,800 $100 4 4• 152 $3,600 $600 $4,200 $200 2 3.947368• 152 $4,000 $600 $4,600 0 3.947368
AFC
0
5
10
15
20
25
30
35
0 50 100 150 200
TP
COSTS
AFC
AVC• TP TVC TFC TC MC MP AFC AVC• 0 $0 $600 $600 • 20 $400 $600 $1,000 $20 20 30 20• 44 $800 $600 $1,400 $17 24 13.636 18.182• 75 $1,200 $600 $1,800 $13 31 8 16• 102 $1,600 $600 $2,200 $15 27 5.8824 15.686• 123 $2,000 $600 $2,600 $19 21 4.878 16.26• 137 $2,400 $600 $3,000 $29 14 4.3796 17.518• 146 $2,800 $600 $3,400 $44 9 4.1096 19.178• 150 $3,200 $600 $3,800 $100 4 4 21.333• 152 $3,600 $600 $4,200 $200 2 3.9474 23.684• 152 $4,000 $600 $4,600 0 3.9474 26.316
MC/AVC
$0
$5
$10
$15
$20
$25
$30
$35
$40
$45
$50
0 20 40 60 80 100 120 140 160
TP
COSTS Series1
Series2
ATCTP TVC TFC TC MC MP AFC AVC ATC
0 $0 $600 $600
20 $400 $600 $1,000 $20 20 30 20 50
44 $800 $600 $1,400 $17 24 13.636 18.182 31.8182
75 $1,200 $600 $1,800 $13 31 8 16 24
102 $1,600 $600 $2,200 $15 27 5.8824 15.686 21.5686
123 $2,000 $600 $2,600 $19 21 4.878 16.26 21.1382
137 $2,400 $600 $3,000 $29 14 4.3796 17.518 21.8978
146 $2,800 $600 $3,400 $44 9 4.1096 19.178 23.2877
150 $3,200 $600 $3,800 $100 4 4 21.333 25.3333
152 $3,600 $600 $4,200 $200 2 3.9474 23.684 27.6316
152 $4,000 $600 $4,600 0 3.9474 26.316 30.2632
AFC/ATC/MC
$0
$10
$20
$30
$40
$50
$60
0 20 40 60 80 100 120 140 160TP
COSTS Series1
Series2
Series3
Minimizing ATC
Q*
level of output that minimizes the average costs for this particular plant size.
Summary of short-run cost curves• AVC is always less than ATC (difference is AFC)• MC intersects AVC and ATC at their minimum points.
– Because when MC<AVC this causes AVC to decline and when MC>AVC it causes AVC to rise.
– The same reason also applies to ATC curve.• The short-run means that a firm has a fixed input, usually
it’s plant size.– Q* the level of output that minimizes ATC for the particularly
plant size.• TP<Q* means the plant is UNDERUTILIZED, that is why TC decline• TP>Q* means the plant is OVERUTILIZED,and as the plant gets close
to it’s production limit AC rise very rapidly
Output Decisions
• Question: How can we use what we know about production technology, costs, and competitive markets to make output decisions?
Reminders...
• Firms operate in perfectly competitive output markets.
• In perfectly competitive industries, prices are determined in the market and firms are price takers.
• The demand curve for the firm is perfectly elastic.
Total and Marginal Revenue
• Total revenue is amount of revenue the firm takes in from the sale of its product.
• TR = price x quantity sold• Marginal revenue is additional revenue that
a firm takes in when it increases output by one additional unit.
• MR = TR / q
Perfectly elastic demand curve• In a perfectly competitive market, the firm’s demand curve
is the firm’s marginal revenue curve.
$5
Price per unit
s
d
$5
Price per unit
D=MR
The firm maximizes profits by producing where MR = MC
$5
Price per unit
s
d
$5
Price per unit
D=MR
MC
Why is q=300 the profit-maximizing level of output for the firm?
$5
Price per unit
D=MR
MC
ATC
100 250 300 340 Q
What will be the firm’s profit level at profit-maximizing level of output?
$5
Price per unit
D=MR
MC
ATC
100 250 300 340 Q
$3.5
Example
• Table 8.5• Minimizing ATC point : q*=4• Maximizing profit point: 4<q<5• In this question, we chose q=4
– If q>4, we can only choose q=5 which MR=15, MC=20, profit=-5.
Chapter Summary
• Firm production costs can be fixed or variable, and can be measured in different ways.
• The law of diminishing returns determines the shape of the short-run cost curves.
• Minimizing cost of AFC.• The profit-maximizing firm will produce
output where MC=MR.