Economics Micro & Macro (CliffsAP)

Marginal Cost and Marginal Product

Remember that the marginal cost curve indicates what occurs when more workers are hired. In the beginning, the added
units of labor may decrease the cost of output; however, as more units of labor are added, the cost of output rises. When
diminishing marginal returns set in, the cost of output begins to rise, and firms would be wise not to add units of labor.
Marginal cost is the change in cost caused by a change in output.

Marginal Cost, Average Variable Cost, Average Total Cost

When the amount added of marginal cost to total cost is less than the current average total cost, the average total cost
falls. The marginal cost that is less than the average total cost brings down the cost of output. On the other hand, when
the marginal cost is more than the average total cost, the average total cost rises. As long as the marginal cost curve is
below the average total cost, the average total cost will continue to fall, and whenever the marginal cost curve is above
the average total cost curve, the average total cost will increase.

Cost Curve Changes

When a firm experiences changes in resource prices or technology costs, the firm’s cost curves will shift. If the fixed
costs increase, the average fixed cost curve and the average total cost curve shift upward. However, if the price of a
variable cost (such as labor) increases, then the marginal cost curve, average variable cost curve, and average total cost
curve will all shift upward.

Production Costs in the Long Run

In the long run, firms can adjust the resources they use to take advantage of more efficient means of production. Firms
can change the amount of all inputs used, alter the building size, or change the machinery capabilities. Improvements in
technology make production costs cheaper in the long run.

The Long-Run Cost Curve

As you’ve seen, short-run cost curves are U-shaped because of diminishing marginal productivity; long-run curves
are also U-shaped but not because of fixed output. Long-run cost curves are U-shaped due to economies of scale.
Economies of scale means that higher production translates into lower average production costs. The more firms
choose to produce, the less costly production of units becomes. A firm’s ability to decrease its inputs in order to adjust
costs is what makes it cheaper for the firm to produce in the long run.

Constant returns to scaleis the area where all inputs are increased by the same percentage to maintain the lowest pos-
sible per-unit cost. This area is located at the bottom of the long-run average total cost curve.

Diseconomies of scalemeans that an increase in production yields a higher average cost of production. It refers to the
average cost-per-unit increases in the long run despite fixed inputs. Diseconomies of scale occur when firms become
too large to operate efficiently. Decision-making problems, inefficient use of resources, and bureaucracy are all exam-
ples of factors that could lead to diseconomies of scale. The three long-run costs are depicted in Figure 9-6.

Figure 9-6

Quantity

Average

To t a l

Cost

Diseconomics

of

Scale

Constant

Returns

to Scale

Economics

of

Scale

Production Costs

Production Costs