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.