Slide 2: SR Cost Examples

Slide 2: SR cost examples

This is the author’s graph of the cost function used in your text. In the last lesson, this function was used as the example of the qualifying cost function. The top panel of the graph displays TFC, TVC and STC. The lazy S shape of TVC and STC reflects increasing and then diminishing returns, which was explained in the last two lessons.

SMC is placed in the lower panel along with average cost curves (also called “per unit” curves). Curves in the lower panel are related to the total curves in the top panel in very specific ways. I am shifting my focus to average costs in the lower panel because they are more useful than total costs for the examination of profit-maximizing behavior (to be considered in the lesson to follow).

Note first that minimum SMC in the lower panel (point C) is directly below the inflection point in both the TVC and STC curves. The inflection point marks the onset of diminishing returns, as you recall from the last lesson. If the output level where SMC is minimum can be found, then the onset of diminishing returns can be found without involving the total cost functions.

Average costs are not some new mysterious concept. All averages in economics are similar to an arithmetic average. An arithmetic average is a total divided by the number of items making it up. Therefore:

AFC = TFC/Q , AVC = TVC/Q and SAC = STC/Q.

Average relationships in economics are also called “per unit” relationships because AFC is fixed cost per unit of output, AVC is variable cost per unit of output and SAC is STC per unit of output.