(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 317

292 PART • Producers, Consumers, and Competitive Markets Let’s calculate average variable cost and marginal cost for the first 80 units of output and then see how both cost measures change when we include the additional 20 units produced with overtime labor For the first 80 units, average variable cost is simply the labor cost ($2400 ϭ $30 per unit ϫ 80 units) plus the materials cost ($640 ϭ $8 per unit ϫ 80 units) divided by the 80 units—($2400 ϩ $640)/80 ϭ $38 per unit Because average variable cost is the same for each unit of output, marginal cost is also equal to $38 per unit When output increases to 100 units per day, both average variable cost and marginal cost change The variable cost has now increased; it includes the additional materials cost of $160 (20 units ϫ $8 per unit) and the additional labor cost of $1000 (20 units ϫ $50 per unit) Average variable cost is therefore the total labor cost plus the materials cost ($2400 ϩ $1000 ϩ $640 ϩ $160) divided by the 100 units of output, or $42 per unit What about marginal cost? While the materials cost per unit has remained unchanged at $8 per unit, the marginal cost of labor has now increased to $50 per unit, so that the marginal cost of each unit of overtime output is $58 per day Because marginal cost is higher than average variable cost, a manager who relies on average variable cost will produce too much Second, a single item on a firm’s accounting ledger may have two components, only one of which involves marginal cost Suppose that a manager is trying to cut back production She reduces the number of hours that some employees work and lays off others But the salary of an employee who is laid off may not be an accurate measure of the marginal cost of production when cuts are made Union contracts, for example, often require the firm to pay laid-off employees part of their salaries In this case, the marginal cost of increasing production is not the same as the savings in marginal cost when production is decreased The savings is the labor cost after the required layoff salary has been subtracted Third, all opportunity costs should be included in determining marginal cost Suppose a department store wants to sell children’s furniture Instead of building a new selling area, the manager decides to use part of the third floor, which had been used for appliances, for the furniture The marginal cost of this space is the $90 per square foot per day in profit that would have been earned had the store continued to sell appliances there This opportunity cost measure may be much greater than what the store actually paid for that part of the building These three guidelines can help a manager to measure marginal cost correctly Failure to so can cause production to be too high or too low and thereby reduce profit 8.5 The Competitive Firm’s Short-Run Supply Curve A supply curve for a firm tells us how much output it will produce at every possible price We have seen that competitive firms will increase output to the point at which price is equal to marginal cost, but will shut down if price is below average variable cost Therefore, the firm’s supply curve is the portion of the marginal cost curve for which marginal cost is greater than average variable cost Figure 8.6 illustrates the short-run supply curve Note that for any P greater than minimum AVC, the profit-maximizing output can be read directly from the graph At a price P1, for example, the quantity supplied will be q1; and at P2, it will be q2 For P less than (or equal to) minimum AVC, the profit-maximizing output is equal to zero In Figure 8.6 the entire short-run supply curve consists of the crosshatched portion of the vertical axis plus the marginal cost curve above the point of minimum average variable cost Short-run supply curves for competitive firms slope upward for the same reason that marginal cost increases—the presence of diminishing marginal returns to one or more factors of production As a result, an increase in the market price will induce those firms already in the market to increase the quantities they produce