Maximizing profit as a marginal decision

Chapter 8: Production Costs: Where Less Is More

where q is the quantity of output produced.

Marginal cost always intersects the minimum point on the average total cost curve. Thus, average total cost initially decreases, and then begins to increase, resulting in a U-shaped curve.

Average total cost has two components — average fixed cost and average variable cost. As an equation,

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Average fixed cost

Average fixed cost (AFC) is fixed cost per unit of output and is determined by dividing total fixed cost by the quantity of output. In the total cost equation

total fixed cost is $5,600, so averaged fixed cost is

Because the numerator of average fixed cost is a constant, while the denominator is the quantity of output produced, average fixed cost always decreases as the quantity of output produced increases.

Average variable cost

Average variable cost (AVC) represents variable cost per unit of output and equals total variable cost divided by the quantity of output. Given total variable cost equals

average variable cost equals

Typically, average variable cost initially decreases, and then begins to increase, resulting in a U-shaped curve. Marginal cost intersects the minimum point on the average variable cost curve.

128 Part II: Considering Which Side You’re On in the Decision-Making Process

Figure 8-2 illustrates the average total cost, average fixed cost, average variable cost, and marginal cost curves. Note that the average fixed cost curve is always decreasing and also note that the difference between average total cost and average variable cost is average fixed cost — so AFCb at qb is less than AFC a at qa. Therefore, as you produce more output, average variable cost and average total cost get closer to one another. Finally, marginal cost intersects the minimum points on the average variable and average total cost curves.

Figure 8-2:

Average cost curves and marginal cost.

Deriving Cost Concepts with Calculus (Ignore if You Want)

Equations provide an excellent means of determining the exact cost associated with a given quantity of output. In addition, taking the derivative of an equation provides an opportunity to easily determine the minimum levels of various costs, including marginal cost, average variable cost, and average total cost.

Linking short-run cost functions to production isoquants

Chapter 6 presents production theory. Production costs are directly derived from production theory. In production theory, you determine the