AP_Krugman_Textbook

at the beginning that it would cost $1,750 to repair your car, then the right choice at that

timewould have been to buy a new car for $1,600. But once you have already paid the $250

for brake pads, you should no longer include it in your decision making about your next ac-

tions. It may be hard to “let bygones be bygones,” but it is the right way to make a decision.

Summing Up Costs: The Short and Long of It

If a firm is to make the best decisions about how much to produce, it has to understand

how its costs relate to the quantity of output it chooses to produce. Table 56.1 provides

a quick summary of the concepts and measures of cost you have learned about.

564 section 10 Behind the Supply Curve: Profit, Production, and Costs

Concepts and Measures of Cost

Measurement Definition Mathematical term

Fixed cost Cost that does not depend on the FC

quantity of output produced

Average fixed cost Fixed cost per unit of output AFC=FC/Q

Variable cost Cost that depends on the VC

quantity of output produced

Average variable cost Variable cost per unit of output AVC=VC/Q

Total cost The sum of fixed cost (short run) TC=FC(short run)

and variable cost +VC

Average total cost Total cost per unit of output ATC=TC/Q

(average cost)

Marginal cost The change in total cost MC=ΔTC/ΔQ

generated by producing one

more unit of output

Long -run Average total cost when fixed LRATC

average cost has been chosen to minimize

total cost average total cost for each level

of output

table56.1

Short run

Short run

and

long run

Long run

There’s No Business Like Snow Business

Anyone who has lived both in a snowy city, like

Chicago, and in a city that only occasionally expe-

riences significant snowfall, like Washington, D.C.,

is aware of the differences in total cost that arise

from making different choices about fixed cost.

In Washington, even a minor snowfall—say,

an inch or two overnight—is enough to create

chaos during the next morning’s commute. The

same snowfall in Chicago has hardly any effect

at all. The reason is not that Washing tonians are

wimps and Chicagoans are made of sterner

stuff; it is that Washington, where it rarely

snows, has only a fraction as many snowplows

and other snow-clearing equipment as cities

where heavy snow is a fact of life.

In this sense Washington and Chicago are like

two producers who expect to produce different

levels of output, where the “output” is snow re-

moval. Washington, which rarely has significant

snow, has chosen a low level of fixed cost in the

form of snow-clearing equipment. This makes

sense under normal circumstances but leaves

the city unprepared when major snow does fall.

Chicago, which knows that it will face lots of

snow, chooses to accept the higher fixed cost

that leaves it in a position to respond effectively.

fyi

A lesson in returns to scale: cities with higher

average annual snowfall maintain larger snow-

plow fleets.

AP/Wide World Photos