Cambridge International as and a level Economics Ebook

Short-run costs
Th
ese consist of:
■
Fixed costs: 
These are the costs that are completely 
independent of output. Total fixed cost data when drawn on 
a graph would appear as a horizontal straight line. At zero 
output, any costs that a firm has must be fixed. Some firms 
operate in a situation where the fixed cost represents a 
large proportion of the total. In this case it would be wise to 
produce a large output in order to reduce unit costs and so 
make the firm more eff icient.
■
Variable costs: 
These include all the costs that are 
directly related to the level of output, the usual ones 
being labour and raw material or component costs. In 
other words, variable costs are incurred directly in the 
production process.
Fixed costs: 
those costs that are independent of output in 
the short run.
Variable costs: 
those that vary directly with output; all 
costs are variable in the long run.
KEY TERMS
Important defi nitions are:
Total cost (TC) 
=
total fi xed cost (TFC) 
+
total variable cost (TVC)
Th
ese costs are shown on
 Figure 7.7
.
Further cost measures can now be derived. Th
ey are:
Average fi xed cost (AFC) 
=
total fixed
ff
cost
output
Average variable cost (AVC) 
=
total variable cost
output
Average total cost (ATC) 
=
total cost
output
Marginal cost is the addition to the total cost when 
making one extra unit and is therefore a variable cost. 
Th
ese cost measures are shown in 
Figure 7.8.
Th
e most important cost curve for the fi rm will 
be the ATC, showing the cost per unit of any chosen 
output. For most fi rms the decision to increase output 
will raise the total cost; that is, the marginal cost will be 
positive as extra inputs are used. Firms will only be keen 
to do this when the expected sales revenue will outweigh 
the extra cost. Rising marginal cost is also a refl ection 
of the law of diminishing returns (see above). As more 
of the variable factors are added to the fi xed ones, the 
contribution of each extra worker to the total output will 
begin to fall. Th
ese diminishing marginal returns cause 
the marginal and average variable cost to rise, as shown 
in 
Figure 7.8
.
Th
e shape of the short-run ATC is the result of the 
interaction between the average fi xed cost and the 
average variable cost: AFC 
+
AVC 
=
ATC. As the fi rm’s 
output rises, the average fi xed cost will fall because the 
total fi xed cost is being spread over an increasing 
number of units. However, at the same time, average 
variable cost will be rising because of diminishing 
returns to the variable factor. Eventually this will 
outweigh the eff ect of falling AFC, causing ATC to rise. 
Figure 7.7 
Total cost curves
Costs
Output
Total cost (TC)
Total variable
cost (TVC)
Total fixed
cost (TFC)
0
Figure 7.8 
Average and marginal cost curves
Costs
Output
Marginal cost (MC)
Average Total
cost (ATC)
Average
variable
cost (AVC)
Average
fixed
cost (AFC)
0