Fixed costs remain constant regardless of the level of output in the short run, such as lease payments and maintenance, while variable costs change with output, like fuel and labor. The law of diminishing returns states that as more of a variable input is added to a fixed input, the additional output eventually declines. Total costs increase, but average costs fall and then rise as marginal costs decline and then increase with output as diminishing returns sets in.

1. Costs in the short run

2. Learning outcomes
Understand the
economist’s
concepts of the
short and long
run
Understand the law of
diminishing returns
Explain what is
meant by fixed
and variable
costs

3. Time periods
The long run
that period of time when firms are
able to vary all their factor inputs
The short run
that period of time when firms face the
problem that some of their factor inputs
cannot be changed (fixed)

4. Types of short run costs
Transport examples include:
Cost of leasing aircraft, maintenance of
track (Network Rail), vehicle insurance,
depreciation and maintenance (bus &
train operators, haulage firms)
Fixed costs
Costs which are independent of the
level of output produced

5. Types of short run costs
Transport examples include:
fuel, driver hours
Variable costs
Costs which are directly dependent on
the level of output produced

6. Law of diminishing returns
The more of a variable input that
is added to a fixed input,
eventually the smaller will be the
additional output produced
‘too many cooks spoil the broth’
This causes the ‘marginal product’ to
decline followed by the ‘average product’
 Note that before diminishing returns sets in,
a firm will experience increasing returns

7. Task 1: physical product
 Calculate the total, marginal and average
product from the information given on the
task sheet
 Draw graphs of these relationships on your
task sheet

8. Total physical product
0
20
40
60
80
100
120
140
160
180
200
220
240
260
0 1 2 3 4 5 6 7 8
Labour employed
Physicalproduct

9. Average and marginal physical product
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
35
40
45
50
55
0 1 2 3 4 5 6 7 8
Labour employed
Physicalproduct

10. Task 2: costs
 The variable and total costs of a firm will be
affected by increasing and diminishing
returns
 Calculate the total cost, average variable,
average fixed, average total and marginal
cost on the task sheet
 Important formula:
TC = TFC + TVC
ATC = TC / Q
AVC = TVC / Q
AFC = TFC / Q
MC = TC / Q

11. Fixed, variable and average costs
0
200
400
600
800
1000
1200
1400
1600
1800
2000
2200
2400
0 1 2 3 4 5
Output
Cost(£)

12. Average fixed costs
0
20
40
60
80
100
120
140
160
180
200
220
0 1 2 3 4 5
Output
Cost(£)

13. Average variable, average total and marginal costs
0
50
100
150
200
250
300
350
400
450
500
550
600
0 1 2 3 4 5
Output
Cost(£)