Consider some of the problems often faced by a company like General Motors.

How much assembly-line machinery and how much labor should it use in its new automobile plants? If it wants
to increase production, should it hire more workers, construct new plants, or both?
Does it make more sense for one automobile plant to produce different models, or should each model be
manufactured in a separate plant?
What should GM expect its costs to be during the coming year?
How are these costs likely to change over time and be affected by the level of production?

The Production Decisions of a Firm

The production decisions of firms are analogous to the purchasing decisions of consumers, and can
likewise be understood in three steps:

1. Production Technology

2. Cost Constraints

3. Input Choices

Economic Cost versus Accounting Cost

Fixed versus Sunk Costs
People often confuse fixed and sunk costs. As we just explained, fixed costs are costs that are paid by a firm that
is operating, regardless of the level of output it produces. Such costs can include, for example, the salaries of the
key executives and expenses for their office space and support staff, as well as insurance and the costs of plant
maintenance. Fixed costs can be avoided if the firm shuts
down a plant or goes out of business.

Sunk costs, on the other hand, are costs that have been incurred and cannot be recovered. An example is the
cost of R&D to a pharmaceutical company to develop and test a new drug and then, if the drug has been proven
to be safe and effective, the cost of marketing it. Whether the drug is a success or a failure, these costs cannot be
recovered and thus are sunk. Another example is the cost
of a chip-fabrication plant to produce microprocessors for use in computers. Because the plant’s equipment is
too specialized to be of use in any other industry, most if not all of this expenditure is sunk, i.e., cannot be
recovered.

Why distinguish between fixed and sunk costs? Because fixed costs affect the firm’s decisions looking forward,
whereas sunk costs do not. Fixed costs that are high relative to revenue and cannot be reduced might lead a firm
to shut down—eliminating those fixed costs and earning zero profit might be better than incurring ongoing
losses. Incurring a high sunk cost might later turn out to be a bad decision (for example, the unsuccessful
development of a new product), but the expenditure is gone and cannot be recovered by shutting down.

It is important to understand the characteristics of production costs and to be able to identify which costs are
fixed, which are variable, and which are sunk.

Good examples include the personal computer industry (where most costs are variable), the computer software
industry (where most costs are sunk), and the pizzeria business (where most costs are fixed).
Because computers are very similar, competition is intense, and profitability depends on the ability to keep costs
down. Most important are the cost of components and labor.
A software firm will spend a large amount of money to develop a new application. The company can recoup its
investment by selling as many copies of the program as possible.

For the pizzeria, sunk costs are fairly low because equipment can be resold if the pizzeria goes out of business.
Variable costs are low—mainly the ingredients for pizza and perhaps wages for a workers to produce and
deliver pizzas.

If a computer memory chip manufacturer sells 1 million chips at $0.20 each, its revenues would be
$200,000—$0.20 times the 1 million chips sold.

What the firm uses to produce the goods are called inputs or factors of production: labor, materials, and
capital goods.
The firm’s total costs are sum of the costs of these inputs.
Labor costs are what the company pays for the workers it hires
and the managers it employs to supervise them.
Costs of materials include raw materials and intermediate goods. Intermediate goods are whatever
supplies the company purchases from other firms—such as seeds, fertilizer, and gasoline for a
farm; or iron ore, coal, coke, limestone, and electric power for a steel company.
Costs of capital goods include the cost of machinery and structures such as buildings and factories.

Firms can vary the mix of labor, materials, and capital goods they use; and they will do so until they find the
lowest-cost method of producing a given quality and quantity of product.

For given prices and levels of output, a firm maximizes its profits by finding the least costly way of
producing its output. Thus, profit-maximizing firms are also cost-minimizing firms.

PRODUCTION WITH ONE VARIABLE INPUT

The Production Function
Function showing the highest output that a firm can produce for every specified combination
of inputs.

𝑞 = 𝐹(𝐾, 𝐿)
Production functions describe what is technically feasible when the firm operates
efficiently—that is, when the firm uses each combination of inputs as effectively as possible.
The Short Run versus the Long Run
short run Period of time in which quantities of one or more production factors cannot be
changed.
fixed input Production factor that cannot be varied.
long run Amount of time needed to make all production inputs variable.

The relationship between the quantity of inputs used in production and the level of output is called the
production function. When the number of hours worked per year rises from 8,000 to 9,000, output
increases by 10,000 bushels, from 155,000 to 165,000. The marginal product of an extra 1,000 hours of
labor is thus 10,000 bushels.

A PRODUCTION FUNCTION FOR HEALTH CARE

Do increases in health care expenditures reflect increases in output or do they reflect
inefficiencies in the production process?
The United States is relatively wealthy, and it is natural for consumer preferences to shift toward
more health care as incomes grow. However, it may be that the production of health care in the
United States is inefficient.

Additional expenditures on health care (inputs) increase life expectancy (output) along the
production frontier. Points A, B, and C represent points at which inputs are efficiently utilized,
although there are diminishing returns when moving from B to C. Point D is a point of input
inefficiency.
Diminishing Returns
In the case of the wheat farmer, as more labor is added to a fixed amount of land, the marginal product of
labor diminishes [slope’s flattening out as the amount of labor increases].

Increasing Returns
Imagine a business that picks up garbage. If this business counts only one out of every five houses as
customers, it will have a certain cost of production. But suppose the company can expand to picking up the
garbage from two out of every five houses: while it will need more workers, the workers will be able to drive
a shorter distance per customer and pick up more garbage faster. Thus, a doubling of output can result
from a less than doubling of labor.

Many examples of increasing returns, like garbage collection, involve providing service to more people in a
given area. Telephone companies and electric utilities are two other familiar instances.

Constant Returns
Each additional unit of input increases output by the same amount, and the relationship between input and
output is a straight line.

It is important to recognize that most production functions can display all three types of returns at
different levels of production. For example, at low levels of output, the addition of a unit of input may
lead to a more than proportionate increase in output. As more and more of the input is added, however,
diminishing returns eventually sets in.

Imagine a large plot of land planted in corn. With the addition of only 5 pounds of nitrogen fertilizer per
acre, the corn yield might be quite low, say 35 bushels per acre. Doubling the amount of fertilizer to 10
pounds per acre might more than double yields to 80 bushels per acre—an example of increasing
returns. Doubling the use of fertilizer again to 20 pounds per acre increases yields to 160 bushels per
acre. The impact is proportionately less than when fertilizer use was increased from 5 to 10 pounds per
acre. Doubling the use of fertilizer from 10 to 20 pounds doubled the yield, a case of constant returns to
scale. If the farmer again doubles the fertilizer applied, to 40 pounds per acre, yields again rise, say to 200
bushels per acre. Now yields less than double, so diminishing returns to fertilizer use have set in.

Costs in the Short Run

The change in variable cost is the per-unit cost of the extra labor w times the amount of extra labor
needed to produce the extra output ΔL. Because ΔVC = wΔL, it follows that

MC = ∆VC⁄∆𝑞 = 𝑤∆𝐿⁄∆𝑞
The extra labor needed to obtain an extra unit of output is ΔL/Δq = 1/MPL. As a result,

MC = 𝑤⁄MP𝐿
DIMINISHING MARGINAL RETURNS AND MARGINAL COST

Diminishing marginal returns means that the marginal product of labor declines as the quantity of
labor employed increases.

As a result, when there are diminishing marginal returns, marginal cost will increase as output
increases.

Consider a would-be farmer who has the opportunity to buy a farm and its equipment for $25,000.
Her fixed costs are $25,000.
Marginal Cost and the Marginal Cost Curve

Total Costs
Note that the curve is upward sloping, like the total cost curve, which reflects the fact that as more is
produced, it becomes harder and harder to increase output further. This is an application of the familiar
principle of diminishing marginal returns.

Average Cost and the Average Cost Curve

 With diminishing returns to an input, marginal costs
increase with the level of output, giving the marginal cost
curve its typical, upward-sloping shape.

Average costs initially fall with increased output, as fixed

costs are spread over a larger amount of output, and
then begin to rise as diminishing returns to the variable
input become increasingly important.

Thus, the average cost curve is typically U-shaped.

With a U-shaped average cost curve, the marginal
cost curve will cross the average cost curve at its
minimum.

Average variable costs

Even if the average cost curve is U-shaped, the output at which average costs are lowest may be very
great—so high that there is not enough demand to justify producing that much. As a consequence,
the industry will produce at an output level below that at which average cost are lowest. When the average
cost curve is U-shaped, average costs are declining at output levels that are less than the minimum
average cost level of production. Thus an industry producing less than the output that results in minimum
average costs will be operating in the region where average costs are declining.

When economists say that an industry has declining average costs, they usually do not mean that average
costs are declining at all levels of output. Instead, they typically mean that costs are declining at the output
levels at which the industry is currently producing.

Relationship Between Average and Marginal Cost Curves

The marginal cost curve intersects the average cost curve at the bottom of the U—the minimum average
cost. To understand why the marginal cost curve will always intersect the average cost curve at its
lowest point, consider the relationship between average and marginal costs.

As long as the marginal cost is below the average cost, producing an extra unit of output will pull down
average costs. Thus, everywhere the marginal cost is below the average cost, the average cost curve is
declining. If the marginal cost is above the average cost, then producing an extra unit of output will raise
average costs. So everywhere that the marginal cost is above the average cost, the average cost curve
must be rising.

Changing Input Prices and Cost Curves

An increase in the price of a variable input like labor would shift the total, average, and marginal cost
curves upward
An increase in the price of a variable factor shifts the total, average, and marginal cost curves upward.

Example: Deborah’s Web Consulting Business

Deborah tutors for the computer science department at her college, earning $5 per hour.
She works a total of 20 hours per week, which is the most she can devote to working while still maintaining
good grades in her own courses. Recently, she decided to start her own business helping professors
create Web pages for their classes. Deborah plans to charge $20 per hour for this service. To get started,
she had to purchase $125 worth of software, and she needed to obtain a faster laptop. A local computer
store leased her the laptop she needs for $60 per month.
Costs Deborah faces in her first week of business if she works 10 hours for her new business (and
continues to work 10 hours tutoring) and if she works 20 hours for her new business (and so quits tutoring
completely):

(loss: $35)
Up to this point, we have referred to the distinction between inputs that are fixed (their cost does not vary
with quantity produced) and inputs that are variable (their cost does depend on quantity produced). We
have sidestepped the fact that inputs, and costs, may be fixed for some period of time but can vary with
production over a longer period.

Take the inputs of labor and machines, for example. In the short run, the supply of machines may be
fixed. Output is then increased only by increasing labor. In the longer run, the numbers of both machines
and workers can be adjusted. The short-run cost curve, then, is the cost of production with a given stock of
machines. The long-run cost curve is the cost of production when all factors are adjusted.

Short-run average cost curves are normally U-shaped [machines fixed, labor varies].

THE SHORT-RUN COST OF ALUMINUM SMELTING

The production of aluminum begins with the mining of bauxite. The process used to separate the oxygen
atoms from aluminum oxide molecules, called smelting, is the most costly step in producing aluminum. The
expenditure on a smelting plant, although substantial, is a sunk cost and can be ignored. Fixed costs are
relatively small and can also be ignored.
EXAMPLES USING EXCEL SHEET
 MORE EXAMPLES

Production function of your effort and study

Suppose you study for tomorrow’s exam: your understanding in the first
hour is high because of your tremendous energy and will power/sincerity
towards scoring high, second hour – because of chain-linked
understanding returns (chapters/syllabus sections covered, e.g.)
become higher (increasing returns- due to specialization), then you find
in the 3rd to 4 th hour (or less !!) is not that great !! and then on the 5th
hour you find you are unable to add to your understanding at all..you are
exhausted ….

Average and marginal costs:

Average marks: Representative marks of a class…or for yourself…Your

gpa on an average and marginal gpa might pull down your average
gpa…

The Structure of Costs in the Short Run

The cost of producing a firm’s output depends on how much labor and physical
capital the firm uses. A list of the costs involved in producing cars will look very
different from the costs involved in producing computer software or haircuts or fast-
food meals. However, the cost structure of all firms can be broken down into some
common underlying patterns. When a firm looks at its total costs of production in the
short run, a useful starting point is to divide total costs into two categories: fixed
costs that cannot be changed in the short run and variable costs that can be
changed.

Cost of producing haircuts:

Labor Quantity Fixed Cost Variable Cost Total Cost

1 16 $160 $80 $240

 Labor Quantity Fixed Cost Variable Cost Total Cost

2 40 $160 $160 $320

3 60 $160 $240 $400

4 72 $160 $320 $480

5 80 $160 $400 $560

6 84 $160 $480 $640

7 82 $160 $560 $720

Output and Total Costs

Average total cost is total cost divided by the quantity of output. Since the total cost
of producing 40 haircuts is $320, the average total cost for producing each of 40
haircuts is $320/40, or $8 per haircut. Average cost curves are typically U-shaped.
Average total cost starts off relatively high, because at low levels of output total costs
are dominated by the fixed cost; mathematically, the denominator is so small that
average total cost is large. Average total cost then declines, as the fixed costs are
spread over an increasing quantity of output. In the average cost calculation, the rise
in the numerator of total costs is relatively small compared to the rise in the
denominator of quantity produced. But as output expands still further, the average
cost begins to rise. At the right side of the average cost curve, total costs begin rising
more rapidly as diminishing returns kick in.

Average variable cost obtained when variable cost is divided by quantity of output.
For example, the variable cost of producing 80 haircuts is $400, so the average
variable cost is $400/80, or $5 per haircut. Note that at any level of output, the
average variable cost curve will always lie below the curve for average total
cost. The reason is that average total cost includes average variable cost and
average fixed cost. Thus, for Q = 80 haircuts, the average total cost is $8 per haircut,
while the average variable cost is $5 per haircut. However, as output grows, fixed
costs become relatively less important (since they do not rise with output), so
average variable cost sneaks closer to average cost. Average total and variable
costs measure the average costs of producing some quantity of output. Marginal
cost is somewhat different.

Marginal cost is the additional cost of producing one more unit of output. So it is not
the cost per unit of all units being produced, but only the next one (or next few).
Marginal cost can be calculated by taking the change in total cost and dividing it by
the change in quantity. For example, as quantity produced increases from 40 to 60
haircuts, total costs rise by 400 – 320, or 80. Thus, the marginal cost for each of
those marginal 20 units will be 80/20, or $4 per haircut. The marginal cost curve is
generally upward-sloping, because diminishing marginal returns implies that
additional units are more costly to produce. A small range of increasing marginal
returns can be seen in the figure as a dip in the marginal cost curve before it starts
rising. There is a point at which marginal and average costs meet, as explained
below.

These new measures analyze costs on a per-unit (rather than a total) basis and
are reflected in the curves shown.

Cost Curves at the Clip Joint. The information on total costs, fixed cost, and variable cost can also be
presented on a per-unit basis. Average total cost (ATC) is calculated by dividing total cost by the total quantity
produced. The average total cost curve is typically U-shaped. Average variable cost (AVC) is calculated by
dividing variable cost by the quantity produced. The average variable cost curve lies below the average total
cost curve and is typically U-shaped or upward-sloping. Marginal cost (MC) is calculated by taking the change
in total cost between two levels of output and dividing by the change in output. The marginal cost curve is
upward-sloping.

Where do marginal and average costs meet?

The marginal cost line intersects the average cost line exactly at the bottom of the
average cost curve—which occurs at a quantity of 72 and cost of $6.60. The reason
why the intersection occurs at this point is built into the economic meaning of
marginal and average costs.

If the marginal cost of production is below the average cost for producing previous
units, as it is for the points to the left of where MC crosses ATC, then producing one
more additional unit will reduce average costs overall—and the ATC curve will be
downward-sloping in this zone. Conversely, if the marginal cost of production for
producing an additional unit is above the average cost for producing the earlier units,
as it is for points to the right of where MC crosses ATC, then producing a marginal
unit will increase average costs overall—and the ATC curve must be upward-sloping
in this zone. The point of transition, between where MC is pulling ATC down and
where it is pulling it up, must occur at the minimum point of the ATC curve.
This idea of the marginal cost “pulling down” the average cost or “pulling up” the
average cost may sound abstract, but think about it in terms of your own grades. If
the score on the most recent quiz you take is lower than your average score on
previous quizzes, then the marginal quiz pulls down your average. If your score on
the most recent quiz is higher than the average on previous quizzes, the marginal
quiz pulls up your average. In this same way, low marginal costs of production first
pull down average costs and then higher marginal costs pull them up.

The numerical calculations behind average cost, average variable cost, and marginal
cost will change from firm to firm. However, the general patterns of these curves, and
the relationships and economic intuition behind them, will not change.

------------------------------------

Consider a hypothetical firm, Acme Clothing, a shop that produces jackets.

Suppose that Acme has a lease on its building and equipment. During the period
of the lease, Acme’s capital is its fixed factor of production. Acme’s variable
factors of production include things such as labor, cloth, and electricity. In the
analysis that follows, we shall simplify by assuming that labor is
Acme’s only variable factor of production.
Suppose that Acme pays a wage of $100 per worker per day.
Increasing output from 6 to 7 units (ΔQ=1) increases total cost from $480 to $500
(ΔTC=$20). The seventh unit thus has a marginal cost of $20
(ΔTC/ΔQ=$20/1=$20). Marginal cost falls over the range of increasing marginal
returns and rises over the range of diminishing marginal returns.
 Relating returns and costs

LONG-RUN COST CURVES

Though short-run average cost curves for a given manufacturing facility are typically U-shaped, the firm’s
long-run average cost curve may have a quite different shape. As production grows, it will pay at some
point to build a second plant, and then a third, a fourth, and so on.

The total costs of producing different levels of output when the firm builds two plants; this cost curve is
labeled TC2. If production is very low, it is cheaper to produce using only a single plant (TC1 is below
TC2), but as the level of production increases, it becomes more and more costly to try to handle all
production in a single plant; total costs are lower if two plants are used, so TC1 eventually rises above TC2.

How many plants should the company build?

Clearly, the firm wishes to minimize the total cost of producing at any output level.
If it produces less than Q1, total costs are lowest if the firm has only one plant. Between Q1 and Q2, total
costs are lowest if the firm has two plants. And if the firm produces more than Q2, total costs are lowest if it
uses three plants.

Thus, the relevant longrun total cost curve when the firm is able to adjust the number of plants it has is the
lower boundary of the three curves in the figure. The long-run total cost curve is the darker curve.
Once the company has decided how much output it will choose the number of plants that minimizes its
average costs. Thus, if the firm plans to produce less than Q1, it builds only one plant; AC1 is less than AC2
for all outputs less than Q1. If the firm plans to produce between Q1 and Q2, it builds two plants, because in
this interval, AC2 is less than either AC1 or AC3.

Suppose there is a food truck business selling tacos …how many food trucks to buy? We do market
research…target 200 tacos sell per day implying you need 2 trucks…fixed cost is truck cost..var cost –
staff, food material cost etc…..Target MIN ATC per day….what if you end up selling 100 tacos per
day?then our costs per taco will he higher (70 cents here)…let’s say tacos sell better>200 – say 300,…then
we can change our fixed cost…say 3 trucks..per cost is now 80 cents..

In LR you can adjust ----see if taco sells 100 you think let’s sell one truck..costs avg 60 cents…(yellow
SRATC)..this will be suboptimal if we actually have 200 orders or more…In LR if you find selling more you
may buy another truck and then avrg cost (per taco) falls (blue SRATC)…in LR we will be picking optimal
number of qnty producing…connect the min points and get LRATC curve- the envelope of all your
SRATCs…at any given qnty you chose min points of your SRATCs.. will there be 1.5 units of truck? Well
in LR you can have a custom truck size as well !!
 ---------------------------

-----------------------------------
The bumps in the long-run average cost curve arise because we have assumed the only alternatives in the
long run that are available to the firm involve building one, two, or three plants. We have ignored the many
other options a firm has. If the firm is operating one plant, it can expand by, say, adding a new assembly
line rather than building a whole new plant. Or it can add new machines to its current plant. These
types of adjustments would lead to a series of total cost curves between TC1 and TC2. When we take into
account all the options a firm typically adjust its fixed costs, the bumps in the long-run average cost curve
will become progressively smaller, enabling us to ignore them in most cases. Thus, when we draw a long-
run average cost curve, we will typically ignore the bumps and draw a smooth curve.
But what does a smooth long-run average cost curve look like? Does it slope upward or
downward? Or is it flat?

A good way to answer these questions is to ask what happens to average costs if the firm doubles all its
inputs. That is, it doubles the number of workers it employs and the number of plants it operates. If output
also doubles when inputs are doubled, then average costs will remain unchanged.

In this case, the long-run average cost curve is flat, and we say there are constant returns to scale.
Under these conditions, changing the scale of production leaves average costs constant. Many economists
argue that constant returns to scale are most prevalent in manufacturing; average cost of teaching
introductory economics to 500 students is the same as it is for teaching it to 250 students. Just add another
lecture hall and hire another lecturer.

As the firm tries to grow, adding additional plants, management becomes more complex. It may have to
add layer upon layer of managers, and each of these layers increases costs. When the firm is small, the
owner can supervise all the workers. When the firm grows, the owner can no longer supervise everyone
and will have to hire a new employee to help supervise. As the firm grows even larger, and more
supervisors are hired, eventually the owner needs someone to help supervise the supervisors. Doubling
the output of the firm may require not just doubling existing inputs but adding new layers of bureaucracy
that can slow decision making in the firm, adding further to costs. This case is an example of diminishing
returns to scale.

Suppose that increasing all inputs in proportion leads to a more than proportionate increase in output.
Suppose, for example, that when all inputs are increased by 20 percent, output jumps by 25 percent. This
is a case of increasing returns to scale, sometimes described as economies of scale.

For most firms, however, diminishing returns to scale eventually set in as production levels become very
large. As the firm increases its size, adding additional plants, it starts to face increasing managerial
problems; it may have to add layer upon layer of management, and each of these layers increases costs.
Long-run average costs start to rise with output at high levels of output. Yet in some industries, increasing
returns to scale are possible even for very large outputs. As the firm produces a higher output, it can take
advantage of machines that are larger and more efficient than those used by smaller firms. Software
companies may enjoy increasing returns to scale

Returns to Scale in the Real World

An increase in the price of any input shifts the cost function up.

In some cases, substitution is quick and easy; in other cases, it may take time and be difficult.
When the price of oil increased fourfold in 1973 and doubled again in 1979, firms found many ways to
economize on the use of oil. For instance, companies switched from oil to natural gas (and in the case of
electric power companies, often to coal) as a source of energy. More energy-efficient cars and trucks were
constructed, often using lighter materials such as aluminum and plastics. These substitutions took time, but
they did eventually occur.

The principle of substitution should serve as a warning to those who think they can raise prices
without bearing any consequences. For example, Argentina has almost a world monopoly on linseed oil.
At one time, linseed oil was universally used for making high-quality paints. Since there was no
competition, Argentina decided that it would raise the price of linseed oil, assuming everyone would have to
pay it. But as the price increased, paint manufacturers learned to substitute other natural oils that could do
almost as well.

Raising the price of labor (wages) provides another example. Unions in the auto and steel
industries successfully demanded higher wages for their members during the boom periods of the 1960s
and 1970s, and firms paid the higher wages. But at the same time, the firms redoubled their efforts to
mechanize their production and to become less dependent on their labor force. Over time, these efforts
were successful and led to a decline in employment in those industries.

Tangency condition for cost minimization in the form given in expression is, MPL/w  MPK/r. This
has a nice intuitive interpretation and is something firms might actually be able to use to ascertain if
they are using the least-cost combination of inputs. For example, suppose a roofing firm is using 3
workers and 2 nailing guns and can roof 100 square feet in an hour. If they had one more worker they
could roof 120 square feet, or if they had one more nail gun they could roof 110 square feet. Workers
are paid $12 per hour and nail guns cost $3 per hour. From this you can estimate the marginal
products and determine that the firm is not at the cost-minimizing point. It should use relatively more
nail guns.

Most firms produce more than one good. Deciding which goods to produce and in what quantities, as well
as how to produce them, are central problems facing firm managers.

Joint products: From crude oil, a petroleum refinery can produce gasoline, lubricating oils, and diesel fuel.
If more crude oil is distilled into gasoline, more lubricating oil and diesel fuel will also be produced as by-
products of the process.

If it is less expensive to produce a set of goods together than separately, economists say there are
economies of scope. The concept of economies of scope helps us understand why certain activities are
often undertaken by the same firm.

Your mobile phone company probably also provides text-messaging services.

A company like PeopleSoft, now part of Oracle, provides software for a variety of business needs,
such as human resources, finance, information technology, procurement, marketing, services, and sales.
It is less expensive for one company to produce all these software services together than it would be to
produce each one separately.
Economies of Scale

Refers to the situation in which output grows proportionately faster than inputs.

Economies of Scope

Refer to the lowering of costs that a firm often experiences when it produces two or more products together
rather than each alone.

Summary of Notation and Formulas – chapter 8 of Salvator (textbook)

(8-1) 𝑇𝐶 = 𝑇𝐹𝐶 + 𝑇𝑉𝐶

𝑇𝐹𝐶
(8-2) 𝐴𝐹𝐶 = 𝑄

𝑇𝑉𝐶
(8-3) 𝐴𝑉𝐶 = 𝑄

𝑇𝐶
(8-4) 𝐴𝑇𝐶 = = 𝐴𝐹𝐶 + 𝐴𝑉𝐶
𝑄

Δ𝑇𝐶 Δ𝑇𝑉𝐶
(8-5) 𝑀𝐶 = =
Δ𝑄 Δ𝑄

Equations 8–1 through 8–5 define the family of short-run cost functions. Equation 8-1 defines
short-run total cost (TC) as total fixed cost (TFC) plus total variable cost (TVC). Equations 8–2, 8–
3, and 8–4 define average fixed cost (AFC), average variable cost (AVC), and average total cost
(ATC) as the ratio of the relevant total cost divided by output (Q). Equation 8-5 defines marginal
cost (MC) as the change in short-run total cost or, equivalently, the change in total variable cost
divided by the corresponding change in output.