2 Short Run Cost Jalil Sir

Short-Run Costs
and Output Decisions

Jalil Choudhury
SHORT-RUN COSTS AND

OUTPUT DECISIONS
firms in perfectly competitive industries make three

specific decisions.
COSTS IN THE SHORT RUN

fixed
cost Any cost that does not depend

on the firms level of output. These costs are
incurred even if the firm is producing nothing.
There are no fixed costs in the long run.
variable
cost A cost that depends on the

level of production chosen.
total
cost (TC) Fixed costs plus variable

costs.
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FIXED COSTS
Total Fixed Cost (TFC)
total fixed costs (TFC) or overhead The total of all

costs that do not change with output, even if output is
zero.
Firms have no control over fixed costs in the short run.

For this reason, fixed costs are sometimes called sunk
costs.
sunk costs Another name for fixed costs in the short
run because firms have no choice but to pay them.
Average Fixed Cost (AFC)
average fixed cost (AFC) Total fixed cost divided by the

number of units of output; a per-unit measure of fixed
costs.
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VARIABLE COSTS
Total Variable Cost (TVC)
total variable cost (TVC) The total of all
costs that vary with output in the short run.
total
variable cost curve A graph that shows

the relationship between total variable cost
and the level of a firms output.
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Marginal Cost (MC)
marginal cost (MC) The increase in total
cost that results from producing one more
unit of output. Marginal costs reflect changes
in variable costs.
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Although the easiest way to derive marginal cost is to

look at total variable cost and subtract, do not lose sight
of the fact that when a firm increases its output level, it
hires or demands more inputs.
Marginal cost measures the additional cost of inputs
required to produce each successive unit of output.
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In
the short run, every firm is constrained by

some fixed input that
(1) leads to diminishing returns to variable inputs

and
(2) limits its capacity to produce.
As
a firm approaches that capacity, it

becomes increasingly costly to produce
successively higher levels of output.
Marginal costs ultimately increase with output
in the short run.
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Average Variable Cost (AVC)

average variable cost (AVC) Total variable cost
divided by the number of units of output.
Marginal cost is the cost of one additional unit.

Average variable cost is the total variable cost
divided by the total number of units produced.
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Average Total Cost (ATC)
average total cost (ATC) Total cost divided
by the number of units of output.
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The Relationship Between Average Total Cost and
Marginal Cost
The relationship between average total cost and

marginal cost is exactly the same as the relationship
between average variable cost and marginal cost.
If marginal cost is below average total cost, average total cost

will decline toward marginal cost.
If marginal cost is above average total cost, average total cost
will increase.
As a result, marginal cost intersects average total cost at ATCs
minimum point, for the same reason that it intersects the average
variable cost curve at its minimum point.
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OUTPUT DECISIONS: REVENUES,

COSTS, AND PROFIT MAXIMIZATION
TOTAL REVENUE (TR)&MARGINAL REVENUE (MR)
total revenue (TR) The total amount that a firm

takes in from the sale of its product: the price per
unit times the quantity of output the firm decides to
produce (P x q).
marginal revenue (MR) The additional revenue that

a firm takes in when it increases output by one
additional unit. In perfect competition, P = MR.
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As long as marginal revenue is greater than marginal

cost, even though the difference between the two is
getting smaller, added output means added profit.
Whenever marginal revenue exceeds marginal cost, the
revenue gained by increasing output by one unit per
period exceeds the cost incurred by doing so.
The profit-maximizing perfectly competitive firm will
produce up to the point where the price of its output is
just equal to short-run marginal costthe level of output
at which P* = MC.
The profit-maximizing output level for all firms is the
output level where MR = MC.
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Short-Run Costs

and Output Decisions

SHORT-RUN COSTS AND

firms in perfectly competitive industries make three

COSTS IN THE SHORT RUN

cost Any cost that does not depend

cost A cost that depends on the

cost (TC) Fixed costs plus variable

COSTS IN THE SHORT RUN

total fixed costs (TFC) or overhead The total of all

COSTS IN THE SHORT RUN

Firms have no control over fixed costs in the short run.

Average Fixed Cost (AFC)

average fixed cost (AFC) Total fixed cost divided by the

COSTS IN THE SHORT RUN

variable cost curve A graph that shows

COSTS IN THE SHORT RUN

COSTS IN THE SHORT RUN

COSTS IN THE SHORT RUN

Although the easiest way to derive marginal cost is to

COSTS IN THE SHORT RUN

the short run, every firm is constrained by

(1) leads to diminishing returns to variable inputs

a firm approaches that capacity, it

COSTS IN THE SHORT RUN

Average Variable Cost (AVC)

Marginal cost is the cost of one additional unit.

COSTS IN THE SHORT RUN

COSTS IN THE SHORT RUN

COSTS IN THE SHORT RUN

The relationship between average total cost and

If marginal cost is below average total cost, average total cost

COSTS IN THE SHORT RUN

OUTPUT DECISIONS: REVENUES,

total revenue (TR) The total amount that a firm

marginal revenue (MR) The additional revenue that

OUTPUT DECISIONS: REVENUES,

As long as marginal revenue is greater than marginal

OUTPUT DECISIONS: REVENUES,

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