Costs in the Short Run: NOTE: Costs depend upon output!! Fixed Costs (FC) costs which do not change when a business changes its quantity of output.

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1 Costs in the Short Run: NOTE: Costs depend upon output!! Fixed Costs (FC) costs which do not change when a business changes its quantity of output. Variable Costs (VC) costs which do change when a business changes its quantity of output. Total Cost (TC) sum of all fixed and variable costs at each quantity of output. TC = FC + VC 1

2 Marginal Cost (MC) the extra cost which results when an additional uni of output is produced. found by dividing the change in TC or the change in VC by the change in output (q). Average Fixed Cost (AFC) is the fixed cost per unit of output. Found by dividing FC by the total product (q). Average Variable Cost (AVC) is the variable cost per unit of output. Found by dividing VC cost by the total output (q). Average Cost (AC) the business' total cost per unit of output. found by dividing TC by total output or adding AFC and AVC. 2

3 Example: TP (q) FC VC TC AFC AVC AC MC 0 \$825 \$

4 Page 102 ** NOTES: AFC curve declines continuously. If MC lies below AC or AVC, AC and AVC fall. If MC lies above AC or AVC, AC and AVC rise. If MC intersects the AC or the AVC curve, AC and AVC are at a minimum. 4

5 Page 100 **Notes: MC decreases as long as MP increases. MC is at a minimum when MP is at a maximum. MC increases when MP decreases. 5

6 Production and Costs in the Long Run: Recall Long run consists of all variable factors. As a result, the law of diminishing marginal returns does not apply. When a business is in a position to vary all inputs, there are three situations that may result with regards to output: #1 increasing returns to scale (economies of scale) a situation which occurs in the long run in which a business expands all inputs by a certain percentage and the output increases by a greater percentage. This occurs for three main reasons: (1) division of labour every person has a special task, becoming more efficient at their job. (2) specialized capital each piece of capital equipment is responsible for a special task. (3) specialized management each person in management is assigned a specific role. 6

7 #2 constant returns to scale a situation which occurs in the long run in which a business expands all inputs by a certain percentage and the output increases by the same percentage. #3 decreasing returns to scale (diseconomies of scale) a situation which occurs in the long run in which a business expands all inputs by a certain percentage and the output increases by a smaller percentage. Two main reasons that give rise to diseconomies of scalethis occurs for two main reasons: 1) management difficulties business expands to a point that there are difficulties coordinating operations. 2) limited natural resources 7

8 Page 105 increasing returns to scale decreasing returns to scale constant returns to scale Long Run Average Cost (LRAC) the lowest possible short run average cost curve at each possible level of output. 8

9 Generally: Large businesses are found in industries which benefit from economies of scale while smaller businesses are more prominent in industries involving constant or decreasing returns to scale. economies of scope the cost advantage related to a single business producing different products. gives larger businesses another advantage over smaller ones. 9

10 Complete Practice question 1a) together on page 109. Then complete 1b) and c). Practice Question page 103. Complete Chapter exercises 5 and 6 on page

11 11

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