Ch 8 Micro 13th Edition

Principles of Microeconomics
Thirteenth Edition
Chapter 8
Short-Run Costs and

Output Decisions
Copyright © 2020, 2016, 2011 Pearson Education, Inc. All Rights Reserved
Chapter Outline and Learning
Objectives
8.1 Costs in the Short Run
• Be able to describe and graph the major components of
firm cost.
8.2 Output Decisions: Revenues, Costs, and Profit

Maximization
• Discuss how revenues and costs affect the profit-
maximizing levels of output in perfectly competitive firms.
Looking Ahead
Chapter 8 Short-Run Costs and
Output Decisions (1 of 2)
• This chapter focuses on the costs of production.
• To calculate costs, a firm must know:
– The quantity of inputs needed
– How much those inputs cost
Chapter 8 Short-Run Costs and
Output Decisions (2 of 2)
In their quest for profits, firms make three specific decisions
involving their production.
Figure 8.1 Decisions Facing Firms
Costs in the Short Run
• fixed cost ‫ التكاليف الثابتة‬Any cost that does not
depend on the firm’s level of output. These costs are
incurred even if the firm is producing nothing. There are no
fixed costs in the long run.
• ‫ عقود‬، ‫ ايجار المصنع‬،‫ أقساط البنك‬،‫ أقساط التأمين‬:‫أمثلة‬
‫الصيانة‬
• variable cost ‫ التكاليف المتغيرة‬A cost that depends on
the level of production chosen. ‫ مدخالت‬، ‫رواتب الموظفين‬
‫االنتاج‬
• total cost (TC) Total fixed costs plus total variable costs.
TC  TFC  TVC
Fixed Costs (1 of 2)
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.
• Table 8.1 Short-Run Fixed Cost (Total and Average) of
a Hypothetical Firm
(1) (2) (3)
q TFC AFC (TFC / q)
0 $100 $—
1 100 100
2 100 50
3 100 33
4 100 25
5 100 20
Fixed Costs (2 of 2)
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.
• As output increases, average fixed cost declines because
we are dividing a fixed number ($1,000) by a larger and
larger quantity.
• spreading overhead The process of dividing total fixed
costs by more units of output. Average fixed cost declines
as quantity rises.
Figure 8.2 Short-Run Fixed Cost (Total
and Average) of a Hypothetical Firm
TFC
AFC 
q
Variable Costs (1 of 6)
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
firm’s output.
• A total variable cost curve expresses the relationship
between TVC and total output.
Table 8.2 Derivation of Total Variable Cost
Schedule from Technology and Factor Prices
Produce Using Units of Input Units of Input Total Variable Cost
Technique Required Required Assuming
(Production (Production Pk = $2, PL = $1,
Function) Function) TVC = (K × PK) + (L × PL)
K L
1 unit of A 10 7 (10 × $2) + (7 × $1) = $27
output B 6 8 (6 × $2) + (8 × $1) = $20
2 units of A 16 8 (16 × $2) + (8 × $1) = $40
output B 11 16 (11 × $2) + (8 × $1) = $38
3 units of A 19 15 (19 × $2) + (15 × $1) = $53
output B 18 22 (18 × $2) + (22 × $1) = $58
In this table, total variable cost is derived from production

requirements and input prices.
Figure 8.3 Total Variable Cost Curve
Marginal Cost (MC)
• marginal cost (MC) The increase in total cost that results
from producing 1 more unit of output. Marginal costs reflect
changes in variable costs.
Table 8.3 Derivation of Marginal Cost
from Total Variable Cost
The Shape of the Marginal Cost Curve in the Short Run
• 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.
Figure 8.4 Declining Marginal Product Implies That
Marginal Cost Will Eventually Rise with Output
In the short run, every firm is constrained by some fixed factor of production. A fixed factor
implies diminishing returns (declining marginal product) and a limited capacity to produce.
As that limit is approached, marginal costs rise.
Graphing Total Variable Costs and Marginal Costs
• Total variable costs always increase with output.
• Marginal cost is the cost of producing each additional unit.
• Thus, the marginal cost curve shows how total variable
cost changes with single-unit increases in total output.
ΔTVC ΔTVC
Slope of TVC = = = ΔTVC = MC
Δq 1
Figure 8.5 Total Variable Cost and Marginal Cost for
a Typical Firm
Total variable costs always
increase with output.
Marginal cost is the cost of
producing each additional
unit.
Thus, the marginal cost curve
shows how total variable cost
changes with single-unit
increases in total output.
Average Variable Cost (AVC)
• average variable cost (AVC) Total variable cost divided
by the number of units of output; a per-unit measure of
variable costs.
TVC
AVC 
q
• TC = TFC + TVC
• ΔTC = ΔTFC + ΔTVC
• But ΔTFC = 0 means ΔTC = ΔTVC
Table 8.4 Short-Run Costs of a
Hypothetical Firm
(1) (2) (3) (4) (5) (6) (7) (8)
q TVC MC AVC TFC TC AFC ATC
(Δ TVC) (TVC/q) (TVC + (TFC/q) (TC/q or
TFC) AFC + AVC)
0 $ 0.00 $— $— $100.00 $100.00 $— $—
1 20.00 20.00 20.00 100.00 120.00 100.00 120.00
2 38.00 18.00 19.00 100.00 138.00 50.00 69.00
3 53.00 15.00 17.66 100.00 153.00 33.33 51.00
4 65.00 12.00 16.25 100.00 165.00 25.00 41.25
5 75.00 10.00 15.00 100.00 175.00 20.00 35.00
6 83.00 8.00 13.83 100.00 183.50 16.67 30.50
7 94.50 11.50 13.50 100.00 194.50 14.28 27.78
8 108.00 13.50 13.50 100.00 208.00 12.50 26.00
9 128.50 20.50 14.28 100.00 228.50 11.11 25.39
10 168.50 40.00 16.85 100.00 268.50 10.00 26.85
Graphing Average Variable Costs and Marginal Costs
• When marginal cost is below average cost, average cost is
declining.
• When marginal cost is above average cost, average cost is
increasing.
• Rising marginal cost intersects average variable cost at the
minimum point of AVC.
Figure 8.6 More Short-Run Costs
Total Costs (1 of 4)
Figure 8.7 Total Cost = Total Fixed Cost + Total Variable
Cost
• Adding TFC to TVC means adding the
same amount of total fixed cost to every
level of total variable cost.
• Thus, the total cost curve has the same
shape as the total variable cost curve; it
is simply higher by an amount equal to
TFC.
Average Total Cost (ATC) ) = cost per unit ‫كلفة الوحدة‬
‫الواحدة‬
• average total cost (ATC) Total cost divided by the

number of units of output; a per-unit measure of total
costs.
• ATC = AFC + AVC TC
ATC 
q
• AFC = ATC – AVC or
• AVC = ATC - AFC
Figure 8.8 Average Total Cost = Average Variable
Cost + Average Fixed Cost
• To get ATC, we add
average fixed and average
variable costs at all levels of
output.
• Because average fixed cost
falls with output, an ever-
declining amount is added
to AVC.
• Thus, AVC and ATC get
closer together as output
increases, but the two lines
never meet.
The Relationship between Average Total Cost and
Marginal Cost
• This relationship is the same as the relationship between
AVC and MC.
• If MC is below ATC, ATC will decline toward MC.
• If MC is above ATC, ATC will increase.
• As a result, MC intersects ATC at ATC’s minimum point for
the same reason that it intersects the AVC curve at its
minimum point.
Short-Run Costs: A Review
Table 8.5 A Summary of Cost Concepts
Term Definition Equation
Accounting costs Out-of-pocket costs, or costs as an accountant would —
define them. Sometimes referred to as explicit costs.
Economic costs Costs that include the full opportunity costs of all inputs. —
These include what are often called implicit costs.
Total fixed costs Costs that do not depend on the quantity of output —
(TFC) produced. These must be paid even if output is zero.
Total variable costs Costs that vary with the level of output. —
(TVC)
Total cost (TC) The total economic cost of all the inputs used by a firm TC = TFC + TVC
in production.
Average fixed costs Fixed costs per unit of output. AFC = TFC / q
(AFC)
Average variable Variable costs per unit of output. AVC = TVC / q
costs (AVC)
Average total costs Total costs per unit of output. ATC = TC / q
(ATC) ATC = AFC + AVC
Marginal costs (MC) The increase in total cost that results from producing MC = TC / q
one additional unit of output.
Output Decisions: Revenues, Costs,
and Profit Maximization (1 of 2)
Perfect Competition
• perfect competition An industry structure in which there are
• a) many firms,
• b) each small relative to the industry,
• c) producing identical products and in which
• d) no firm is large enough to have any control over
prices. In perfectly competitive industries, new competitors can
freely enter the market, and old firms can exit.
• homogeneous products Undifferentiated products;

products that are identical to, or indistinguishable from,
one another.
Total Revenue and Marginal Revenue
• 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 × q).
total revenue = price×quantity
TR  P q
• TR = P .Q
• TC = ATC . Q
• PROFIT = TR – TC = P .Q - ATC . Q
• PROFIT = TR – TC or = (P-ATC) . Q
• Average Profit = profit per unit = profit/q
or P-ATC
Figure 8.9 Demand Facing a Single Firm in a
Perfectly Competitive Market
If a representative firm in a perfectly competitive market raises the price of its output above
$5.00, the quantity demanded of that firm’s output will drop to zero.
Each firm faces a perfectly elastic demand curve, d.

Total Revenue and Marginal Revenue
• marginal revenue (MR) The additional revenue that a
firm takes in when it increases output by one additional
unit. In perfect competition, the marginal revenue is equal
to the price. MR= ∆TR÷∆Q = P
• TR= P . Q
• The marginal revenue curve and the demand curve facing
a competitive firm are identical.
• The horizontal line in Figure 8.9(b) can be thought of as
both the demand curve facing the firm and its marginal
revenue curve: 
P  d MR
Comparing Costs and Revenues to
Maximize Profit (1 of 2)
The Profit-Maximizing Level of Output
• 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 1 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 cost—the level of output at which
P* MC.
Comparing Costs and Revenues to
Maximize Profit (2 of 2)
The Profit-Maximizing Level of Output
• The profit-maximizing output level for all firms is the
output level where MR = MC.
• In perfect competition, however, MR = P, as
shown earlier. Hence, for perfectly competitive firms, our
profit-maximizing condition as P = MC= MR.
• Important note: The key idea here is that firms will produce
as long as marginal revenue exceeds marginal cost.
Figure 8.10 The Profit-Maximizing Level of Output
for a Perfectly Competitive Firm
If price is above marginal cost, as it is at every quantity less than 300 units of output, profits
can be increased by raising output; each additional unit increases revenues by more than it
costs to produce the additional output because P > MC. Beyond q* = 300, however, added
output will reduce profits. At 340 units of output, an additional unit of output costs more to
produce than it will bring in revenue when sold on the market. Profit-maximizing output is
thus q*, the point at which P = MC.
A Numerical Example (1 of 2)
Table 8.6 Profit Analysis for a Simple Firm
(1) (2) (3) (4) (5) (6) (7) (8)

TR TC Profit
q TFC TVC MC P = MR (P × q) (TFC + (TR − TC)
TVC)
0 $10 $0 $— $15 $0 $10 $−10
1 10 10 10 15 15 20 −5
2 10 15 5 15 30 25 5
3 10 20 5 15 45 30. 15
4 10 30 10 15 60 40 20
5 10 50 20 15 75 60 15
6 10 80 30 15 90 90 0
A Numerical Example (2 of 2)
• If firms can produce fractional units, it is
optimal to produce between 4 and 5 units.
• The profit-maximizing level of output is thus
between 4 and 5 units.
• The firm continues to increase output as
long as price (marginal revenue) is greater
than marginal cost.
The Short-Run Supply Curve
• At any market price, the marginal cost curve
shows the output level that maximizes profit.
• Thus, the marginal cost curve of a perfectly
competitive profit-maximizing firm is the firm’s
short-run supply curve.
• This is true except when price is so low that it
pays a firm to shut down—a point that will be
discussed in Chapter 9
Figure 8.11 Marginal Cost Is the Supply
Curve of a Perfectly Competitive Firm
Looking Ahead
• Keep in mind that the marginal cost curve carries
information about both input prices and technology.
• With one important exception we will examine in the next
chapter, the marginal cost curve is the perfectly
competitive firm’s supply curve in the short run.
• In the next chapter, we turn to the long run.
Review Terms and Concepts
• average fixed cost (AFC) • total variable cost (TVC)
• average total cost (ATC) • total variable cost curve
• average variable cost (AVC) • variable cost
• fixed cost • Equations:
• homogeneous products TC  TFC  TVC
AFC TFC q
• marginal cost (MC)
Slope of TVC  MC
• marginal revenue (MR)
AVC TVC q
• perfect competition ATC TC q  AFC  AVC
• spreading overhead TR  P  q
• total cost (TC) • profit-maximizing level of output for

• total fixed costs (TFC) or overhead all firms: MR MC
• total revenue (TR) • profit-maximizing level of output for
perfectly competitive firms: P MC

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Principles of Microeconomics

Short-Run Costs and

8.2 Output Decisions: Revenues, Costs, and Profit

Figure 8.1 Decisions Facing Firms

In this table, total variable cost is derived from production

• average total cost (ATC) Total cost divided by the

• homogeneous products Undifferentiated products;

total revenue = price×quantity

Each firm faces a perfectly elastic demand curve, d.

(1) (2) (3) (4) (5) (6) (7) (8)

• total cost (TC) • profit-maximizing level of output for

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