Quiz 7: Production, Inputs, and Cost: Building Blocks for Supply Analysis


If demand is increased suddenly in the market for a product, then the long-run average cost will be lower than the short run average cost of increased output. In long run a firm can manage the production as per requirement. In the long run, a firm can hire labors and purchase new machinery to increase production. In short run, a firm can higher labor or cannot purchase new machinery to increase production, but it can extend the working hours. Increased production lead to an increase in the average cost of the firm. In short run, higher wages to the labor increases the cost of production temporary. In the long run, the increased cost is adjusted as per the requirement. Higher production leads to decrease the average cost of the production. In the long run average cost decreases as the production increases. In short run, firm pays to the labors to work more in the firm. Labor cannot work beyond his limit and the production cannot be increased to the required quantity.

Total fixed cost of the firm remains same for the production of any amount of goods. Average variable cost diminishes as the production of goods increases. Average fixed cost is equal to total fixed cost divided by quantity. Total fixed cost is $360,000 and one has to calculate the average fixed cost. It can be shown with the help of following table. img In the above table, one has taken output from zero to six. Total fixed cost is remained same for every quantity of output. Average fixed cost is calculated by: img With the help of given table one can draw the graph to show the total fixed cost and average fixed cost curves as follows. img The above figure indicates that TFC curve is horizontal straight line considering that the fixed cost is constant. AFC curve slopes downward because AFC declines as the output increases.

Average variable cost is calculated by considering the total variable cost and the quantity. Marginal variable cost is equal to change in total variable cost divided by change in the quantity. The following is a measurement of average variable cost and marginal variable cost. img In the above table, one has calculated the AVC and MVC with the help of given information. Both AVC and MVC increase as the quantity of production increases. The following is graphical representation of the average variable cost, total variable cost, and marginal revenue cost curves. img In the above diagram, one has taken quantity on x-axis and TVC, AVC, and MVC on the y-axis. TVC slopes upward to the right because variable cost increases as output increases. AVC and MVC are constant at initial stage and then both slopes upward. Marginal cost is equal to marginal fixed cost plus marginal average cost. Marginal fixed cost are always zero, therefore the marginal variable cost equals marginal cost. Symbolically, img Therefore, marginal cost is equal to marginal variable cost.

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