Chapter 8: Cost Curves - Short Run & Long Run PDF

# Chapter 8: Cost Curves - Short Run & Long Run ## Chapter Overview We will only cover sections 8.1 and 8.2 in this chapter. ## Short Run vs. Long Run * **Short Run:** Some inputs are fixed ("K") and some inputs are variable ("L"). * **Long Run:** All inputs are variable. ## Total Cost (TC)...

# Chapter 8: Cost Curves - Short Run & Long Run ## Chapter Overview We will only cover sections 8.1 and 8.2 in this chapter. ## Short Run vs. Long Run * **Short Run:** Some inputs are fixed ("K") and some inputs are variable ("L"). * **Long Run:** All inputs are variable. ## Total Cost (TC) * **TC:** *Total Cost* * **TFC:** *Total Fixed Cost* * **TVC:** *Total Variable Cost* **Equation:** TC = TFC + TVC ## Average Cost (AC) * **ATC:** *Average Total Cost* * **AFC:** *Average Fixed Cost* * **AVC:** *Average Variable Cost* **Equations:** * ATC = TC/Q * AFC = TFC/Q * AVC = TVC/Q ## Marginal Cost (MC) **Equation:** MC = ΔTC/ΔQ = dTC/dQ **Definition:** Extra cost from producing one extra unit of output. ## Cost Curve Diagrams **Short Run Cost Curves:** * **TC & TVC:** The vertical distance between TC and TVC is fixed because it represents TFC. * **ATC & AVC:** The vertical distance between ATC and AVC decreases as Q increases because it represents AFC. * **AFC:** AFC is constant as Q increases. **Relationship Between Cost Curves:** * **U-Shape:** AVC and ATC are U-shaped due to diminishing marginal product. * **N-Shape:** MC is N-shaped. ## Long Run Cost Curves **Cost Curves in the Long Run:** * Since all inputs are variable in the long run, all costs are variable. * **TC:** TC = TVC * **ATC:** ATC = AVC **Long Run Average Total Cost (LATC) :** * LATC is the lower envelope of all short-run ATC curves. * LATC shows the lowest cost of producing every quantity. **Why LATC is the Lower Envelope:** * The producer can always change and adjust all his/her inputs in the long run and pick the input bundle that produces what they want with the lowest cost. **Relationship Between LATC and Output:** * **Economies of Scale:** As Q increases, LATC decreases. * **Constant Returns to Scale:** LATC remains constant. * **Diseconomies of Scale:** As Q increases, LATC increases. **Efficient Scale:** * The efficient scale is the output range at which LATC reaches its minimum. ## Short Run vs. Long Run: An Example * In the short run, the firm is forced to use a level of capital that may not be optimal due to input inflexibility. * The firm cannot adjust the optimal level of inputs (K) because it is fixed, which may result in higher production costs. * However, in the long run, all inputs are variable. As a result, the firm can adjust all inputs and produce at its optimal level, which will typically reduce the cost per unit. ## Output Elasticity of Total Cost (ETC) * E_TC,Qmeasures how responsive TC is to the change in output. * **Equation:** E_TC,Q = (%ΔTC)/(%ΔQ) = (ATC * ΔQ)/(TC * ΔQ) = MC/ATC * E_TC,Q < 1 is indicative of economies of scale. * E_TC,Q = 1 is indicative of constant returns to scale. * E_TC,Q > 1 is indicative of diseconomies of scale.