3.4 Short-run Costs

Fixed vs. Variable Costs

In the short run, total fixed cost (TFC) doesn't change with output (rent, insurance) — it's a flat line on a graph. Total variable cost (TVC) rises with output (labor, materials), starting at zero. Total cost (TC) = TFC + TVC. TC and TVC are parallel curves separated vertically by the constant TFC.

Per-Unit (Average) Costs

Divide totals by quantity: AFC = TFC/Q (always falling, since a fixed number is spread over more units), AVC = TVC/Q (U-shaped), and ATC = TC/Q = AFC + AVC (U-shaped). AFC gets smaller as Q rises, so ATC and AVC curves converge but never touch as output increases.

Marginal Cost

Marginal cost (MC) = ΔTC/ΔQ = the cost of producing one more unit. MC is U-shaped due to the law of diminishing marginal returns. MC crosses ATC and AVC at their minimum points — when MC < average, average falls; when MC > average, average rises.

Key terms

Total Fixed Cost (TFC)

Costs that don't change with output in the short run (e.g., rent, insurance); graphs as a horizontal line.

Total Variable Cost (TVC)

Costs that change with the level of output (e.g., labor, raw materials); starts at zero and rises with Q.

Average Total Cost (ATC)

ATC = TC/Q = AFC + AVC; U-shaped curve representing per-unit cost of production.

Marginal Cost (MC)

MC = ΔTC/ΔQ; the cost of producing one additional unit, U-shaped due to diminishing marginal returns.

MC and Average Cost Relationship

When MC is below average cost, average falls; when MC is above average cost, average rises; they intersect at the average's minimum.

Try an AP-style question

Why is the MC curve U-shaped?

1. Fixed costs rise with output
2. Prices fall with output
3. Demand is elastic
4. Increasing then diminishing returns