SHORT-RUN COST CURVES - Managerial Economics

What is Short Run Cost Curve ?

Ashort-run cost curve shows the minimum cost impact of output changes for a specific plant size and in a given operating environment. Such curves reflect the optimal or least-cost input combination for producing output under fixed circumstances. Wage rates, interest rates, plant configuration, and all other operating conditions are held constant.

Any change in the operating environment leads to a shift in short-run cost curves. For example, a general rise in wage rates leads to an upward shift; a fall in wage rates leads to a downward shift. Such changes must not be confused with movements along a given short-run cost curve caused by a change in production levels. For an existing plant, the short-run cost curve illustrates the minimum cost of production at various output levels under current operating conditions. Short-run cost curves are a useful guide to operating decisions.

Short-Run Cost Categories

Both fixed and variable costs affect short-run costs. Total cost at each output level is the sum of total fixed cost (a constant) and total variable cost. Using TC to represent total cost, TFC for total fixed cost, TVC for total variable cost, and Q for the quantity of output produced, various unit costs are calculated as follows:

quantity of output produced, various unit costs

These cost categories are portrayed in Table. Using these data, it is possible to identify the various cost relations as well as to examine cost behavior. Table shows that AFC declines.

Short-Run Cost Curves

Short-Run Cost Curves

continuously with increases in output. AC and AVC also decline as long as they exceed MC, but increase when they are less than MC. Alternatively, so long as MCis less than AC and AVC, both average cost categories will decline. When MC is greater than AC and AVC, both average cost categories will rise. Also note that TFC is invariant with increases in output and that TVC at each level of output equals the sum of MC up to that output.

Marginal cost is the change in cost associated with a one-unit change in output. Because fixed costs do not vary with output, fixed costs do not affect marginal costs. Only variable costs affect marginal costs. Therefore, marginal costs equal the change in total costs or the change in total variable costs following a one-unit change in output:

one-unit change in output

Short-Run Cost Relations

Relations among short-run cost categories are shown in Figure. Figure illustrates total cost and total variable cost curves. The shape of the total cost curve is determined entirely by the total variable cost curve. The slope of the total cost curve at each output level is identical to the slope of the total variable cost curve. Fixed costs merely shift the total cost curve to a higher level. This means that marginal costs are independent of fixed cost.

The shape of the total variable cost curve, and hence the shape of the total cost curve, is determined by the productivity of variable input factors employed. The variable cost curve in Figure increases at a decreasing rate up to output level Q1, then at an increasing rate.

Assuming constant input prices, this implies that the marginal productivity of variable inputs first increases, then decreases. Variable input factors exhibit increasing returns in the range from 0 to Q1 units and show diminishing returns thereafter. This is a typical finding. Fixed

Short-Run Cost Curves

Short-Run Cost Curves

the range of increasing productivity and rises thereafter. This imparts the familiar U-shape to average variable cost and average total cost curves. At first, marginal cost curves also typically decline rapidly in relation to the average variable cost curve and the average total cost curve.

Near the target output level, the marginal cost curve turns up and intersects each of the AVC and AC short-run curves at their respective minimum points.3

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