6.3 COST OF PRODUCTION IN THE SHORT RUN (SHORT RUN COSTS)MUHAMMAD FAHMI AHMAD LATHPI

LEARNING OUTCOMES

0Explain the distinction between the short run & the long run, with reference to fixed costs and variable costs.

0Distinguish between total costs, marginal costs (MC) and average costs (AC)

0Draw diagrams illustrating the relationship between MC & AC, and explain the connection with production in the short run

THE DISTINCTION BETWEEN THE SHORT RUN AND THE LONG RUN0The distinction between short run and long run had

lead us to a distinction between fixed and variable costs

0Fixed costs: costs arise from the use of fixed inputs0Fixed costs do not change as output changes0Even if zero output, payments still have to be made

by the firm in the short run0Arise only in the short run

EXAMPLE OF FIXED COSTS

0Rental payments0Property taxes0Insurance premiums0Interest loans

VARIABLE COSTS0 Variable costs arise from the use of

variable inputs0 The costs vary as output increases or decreases

0 The more variable inputs a firm use, the greater the variable costs

0 Example: WAGE COSTS OF LABOUR0 Firm hires more labour to increases output,

therefore has increased wage costs0TOTAL COSTS: FIXED + VARIABLE COSTS

AVERAGE COSTS0Average costs are costs per unit of output, or total costs (TC)

divided by the number of units of output 0There are 3 total costs, each corresponding to an average

costs:Total CostsAverage Costs

Total fixed costs (TFC) Average fixed costs (AFC)Total variable costs (TVC) Average variable costs (AVC)Total costs (TC) Average costs (AC)

CALCULATE AVERAGE COSTS0Simply divide each of the totals by the unit of output (Q)

that the firm produces:

AVC = ATC =

Note that TC = TFC + TVC

So, ATC = AFC +AVC

MARGINAL COSTS0Marginal costs is the additional cost of producing one

more unit of output. It tells us how much total costs (TC) increase if there is an increase in output (Q) by one unit.

MC = =

(1)TP/Q

(2)Labour

(3)TFC ($)

(4)TVC ($)

(5)TC ($)

(6)AFC ($)

(7)AVC ($)

(8)ATC ($)

(9)MC ($)

0 0 200 0 200 - - - -

2 1 200 100

5 2 200 200

9 3 200 300

14 4 200 400

18 5 200 500

21 6 200 600

23 7 200 700

24 8 200 800

COSTS CURVES & PRODUCT CURVES

0Define a) fixed costs, b) variable costs and c) total costs

0Which is fixed and which are variable???

0Insurance premiums on the value of the property owned by a business

0Interest payments on a loan taken out by a business

0Wage payments to the workers that are hired by a firm

0Payments of the purchase of seeds and fertiliser by a business