Microeconomics: Average Cost and Marginal Cost

Microeconomics Topic 6: “Be able to explain and calculate average and marginal cost to make production decisions.” Reference: Gregory Mankiw’s Principles of Microeconomics, 2nd edition, Chapter 13. Long-Run versus Short-Run In order to understand average cost and marginal cost, it is first necessary to understand the distinction between the “long run” and the “short run.” Short run: a period of time during which one or more of a firm’s inputs cannot be changed. Long run: a period of time during which all inputs can be changed. For example, consider the case of Bob’s Bakery. Bob’s uses two inputs to make loaves of bread: labor (bakers) and capital (ovens). (This is obviously a simplification, because the bakery uses other inputs such as flour and floor space. But we will pretend there are just two inputs to make the example easier to understand.) Bakers can be hired or fired on very short notice. But new ovens take 3 months to install. Thus, the short run for Bob’s Bakery is any period less than 3 months, while the long run is any period longer than 3 months. The concepts of long run and short run are closely related to the concepts of fixed inputs and variable inputs. Fixed input: an input whose quantity remains constant during the time period in question. Variable input: an input whose quantity can be altered during the time period in question. In the case of Bob’s Bakery, ovens are a fixed input during any period less than 3 months, whereas labor is a variable input. Fixed Cost, Variable Cost, and Total Cost In the short run, a firm will have both fixed inputs and variable inputs. These correspond to two types of cost: fixed cost and variable cost. Fixed cost (FC): the cost of all fixed inputs in a production process. Another way of saying this: production costs that do not change with the quantity of output produced.

Variable cost (VC): the cost of all variable inputs in a production process. Another way of saying this: production costs that change with the