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Econ 1B03 - Chapter 13 Part 3.docx

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Hannah Holmes

Econ 1B03 – Chapter 13  Jerry’s total cost function could be written as o C) TC = 200 + 500L  Recalling that TC = TVC + TFC, let’s add these costs to our TC diagram  The TC curve is siply the TVC curve shifted up by the amount of fixed costs   The TC curve gets increasingly steeper.  Costs start to increase faster due to diminishing MP.  Let’s now graph Jerry’s average and marginal costs: o  Minimum of AVC and ATC intersects MC curve at their minimums.  When MC > ATC, ATC increases  When MC > AVC, AVC increases  When MC < ATC or AVC, ATC, AVC is decreasing  When we are at minimum ATC the amount of quantity is our Q point efficient scale. Means you are producing the right amount that minimizes ATC. Also operating at what we call capacity.  MC intersects AVC at min AVC.  MC intersects ATC at min ATC.  Whenever MC < AVC or ATC, AVC and ATC must be falling.  Whenever MC > AVC or ATC, AVC and ATC must be rising.  Min ATC is he point of efficient scale.  We say the firm is operating at capacity (or efficient capacity) – just the right amount of output.  Any Q greater or less than the Q at min ATC has a higher ATC.  If we’re producing Q such that we’re at efficient scale, we are minimizing ATC.  The ATC curve is U-shaped because: o At very low levels of output, ATC is high because fixed cost is spread over only a few units. o ATC declines as Q increases but starts rising because AVC increases substantially.  MC eventually rises with output  The distance between ATC and AVC on the diagram is AFC.  The MC curve is the “inverse” of the MP curve and ATC is the “inverse” of AP  We often omit drawing the AFC curve because as we shall soon see, AFC doesn’t really play a role when firms decide how much to produce in the SR.  Moreover, the MC curves in the diagram in the text are depicted as linear (no doubt for convenience).  Generally, MC decreases initially and then rises as diminishing MP sets in, as in our example of Jerry’s TV’s.  Changes in Short Run Costs  When cost change, the firm’s SR cost structure will change.  For example, say Jerry hires an office manager whose salary increases his fixed costs.  This will also increase his average fixed costs and his average total costs.  These curves will shift up on our SR cost diagram o  Suppose that Jerry’s labour costs increase.  This will increase variable, marginal and total costs.  The AVC, MC and ATC will shift up o  If costs decreased, the affected curves would shift down.  Jerry leases new computers for his office staff and donates the old ones (which were bought and paid for in full 4 years go) to charity. This action will increase ATC and AFC. Costs in the Long Run and Short Run  Because many costs are fixed in the short run but variable
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