Question

1.) When we’re studying an individual firm’s production or costs (not the behavior of a market), how do we define the short run? What do we hold fixed in the short run when we’re studying a firm’s production and costs?

a. Suppose we’re analyzing the behavior of a firm’s costs in the short run. Given that we’re looking at the short run, what do we know about the firm’s marginal cost and average total cost? Briefly explain everything you can about the firm’s marginal cost and average total cost, just based on the fact that we’re talking about the short run.

• Marginal cost (MC):

Average total cost (ATC):

Answer 1

Ans. In short run only labour is variable and capital is fixed i.e. to change the output company has to change the amount of labour as it cannot change the capital in short run. So, cost of capital becomes fixed cost of the firm.

a) In short run the firm’s marginal cost which is the additional cost of employing one more unit of input is actually the wage of the each additional labour employed. It is a U- shaped curve because initially when labour is less the capital is underused, so, increasing the the labour would lead to fall in marginal cost but as more and more labour is employed, fixed capital will start to get overuse and marginal cost starts increasing.

Average total cost is the sum of average variable cost and average fixed cost. It is also U-shaped curve due to the reason same as marginal cost. Average total cost is falling till the point where marginal cost is below it. Marginal cost crosses the average total cost at its minimum point and after this point it is more than the average total cost.

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