This revision webinar focuses on the short run costs of businesses. It includes with examples a distinction between fixed and variable costs, average, marginal and total costs and short and long run costs.

1. Business
Costs
Geoff Riley FRSA
Co-Founder of tutor2u

2. Short Run
• At least one of the factor
inputs is fixed (usually this is
capital but can also be land).
In the short run, businesses
are constrained with fixed &
variable factors.
Long Run
• All factors of production are
variable and the scale of
production can also change
allowing the firm to benefit
from economies of scale
The Short Run and the Long RunThe Short Run and the Long Run

3. Short Run
• At least one of the factor
inputs is fixed (usually this is
capital but can also be land).
In the short run, businesses
are constrained with fixed &
variable factors.
Long Run
• All factors of production are
variable and the scale of
production can also change
allowing the firm to benefit
from economies of scale
The Short Run and the Long RunThe Short Run and the Long Run

4. Short Run
• At least one of the factor
inputs is fixed (usually this is
capital but can also be land).
In the short run, businesses
are constrained with fixed &
variable factors.
Long Run
• All factors of production are
variable and the scale of
production can also change
allowing the firm to benefit
from economies of scale
The Short Run and the Long Run
Key evaluation point: The length of the short run will vary by industry
The Short Run and the Long Run

5. The Short Run and the Long RunFixed Costs
Fixed costs do not vary as the level of
output changes in the short run
The higher the level of fixed costs in a
business, the higher must be the output
in order to break-even

6. The Short Run and the Long RunVariable Costs
Variable costs are costs that relate directly to
the production or sale of a product
Variable cost is determined by the marginal cost
of extra units of output

7. Fixed or variable cost?
Type your answer in the chat window!
Dough used by a
bakery
Packaging used by
online retailers

8. Fixed or variable cost?
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Dough used by a
bakery
Packaging used by
online retailers

9. Fixed or variable cost?
Type your answer in the chat window!
Dough used by a
bakery
Packaging used by
online retailers

10. Fixed or variable cost?
Type your answer in the chat window!
Dough used by a
bakery
Packaging used by
online retailers

11. Fixed or variable cost?
Type your answer in the chat window!
Dough used by a
bakery
Packaging used by
online retailers

12. Fixed or variable cost?
Type your answer in the chat window!
Long term lease on a
distribution /
fulfillment centre
Cost of acquiring a
patent that last 15
years

13. Fixed or variable cost?
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Long term lease on a
distribution centre
Cost of acquiring a
patent that last 15
years
Fixed Cost

14. Fixed or variable cost?
Type your answer in the chat window!
Long term lease on a
distribution centre
Cost of acquiring a
patent that last 15
years
Fixed Cost

15. Fixed or variable cost?
Type your answer in the chat window!
Long term lease on a
distribution centre
Cost of acquiring a
patent that last 15
years
Fixed Cost Fixed Cost

16. Fixed or variable cost?
Type your answer in the chat window!
Workplace
productivity software
Cloud computing
services

17. Fixed or variable cost?
Type your answer in the chat window!
Workplace
productivity software
Cloud computing
services

18. Fixed or variable cost?
Type your answer in the chat window!
Workplace
productivity software
Cloud computing
services

19. Fixed or variable cost?
Type your answer in the chat window!
Workplace
productivity software
Cloud computing
services

20. Fixed or variable cost?
Type your answer in the chat window!
Workplace
productivity software
Cloud computing
services
Key evaluation point: Advances in digital technologies
mean that many fixed costs have become variable costs.

21. Consulting fees Rental Costs Marketing Budgets
Research Projects Fixed salary costs Business insurance
Fixed Costs

22. Commission Bonuses Wage Costs Component parts
Basic raw materials Energy and fuel costs Packaging costs
Variable Costs

23. Cost calculations

24. Output Total Fixed
Cost (£)
0 2000
50 2000
100 2000
150 2000
200 2000
250 2000
300 2000
350 2000
400 2000
Calculating Average Total Cost

25. Output Total Fixed
Cost (£)
Total
Variable
Cost (£)
0 2000 0
50 2000 500
100 2000 700
150 2000 850
200 2000 1000
250 2000 1250
300 2000 1900
350 2000 2550
400 2000 3600
Calculating Average Total Cost

26. Output Total Fixed
Cost (£)
Total
Variable
Cost (£)
Total Cost
(£)
0 2000 0 2000
50 2000 500 2500
100 2000 700 2700
150 2000 850 2850
200 2000 1000 3000
250 2000 1250 3250
300 2000 1900 3900
350 2000 2550 4550
400 2000 3600 5600
Calculating Average Total Cost

27. Output Total Fixed
Cost (£)
Total
Variable
Cost (£)
Total Cost
(£)
Average
Total Cost
(£)
0 2000 0 2000
50 2000 500 2500 50
100 2000 700 2700 27
150 2000 850 2850 19
200 2000 1000 3000 15
250 2000 1250 3250 13
300 2000 1900 3900 13
350 2000 2550 4550 13
400 2000 3600 5600 14
Average cost = total cost / output
Calculating Average Total Cost

28. Output Total Fixed
Cost (£)
Total
Variable
Cost (£)
Total Cost
(£)
Average
Total Cost
(£)
0 2000 0 2000
50 2000 500 2500 50
100 2000 700 2700 27
150 2000 850 2850 19
200 2000 1000 3000 15
250 2000 1250 3250 13
300 2000 1900 3900 13
350 2000 2550 4550 13
400 2000 3600 5600 14
Look at what is
happening to
average cost
Average cost = total cost / output
Calculating Average Total Cost

29. Output Total Fixed
Cost (£)
Total
Variable
Cost (£)
Total Cost
(£)
Average
Total Cost
(£)
Marginal
Cost (£)
0 2000 0 2000
50 2000 500 2500 50 10
100 2000 700 2700 27 4
150 2000 850 2850 19 3
200 2000 1000 3000 15 3
250 2000 1250 3250 13 5
300 2000 1900 3900 13 13
350 2000 2550 4550 13 13
400 2000 3600 5600 14 21
Marginal cost is change in total cost from producing an extra unit of output
Calculating Marginal Cost

30. Output Total Cost
(£)
Average
Total Cost
(£)
Marginal
Cost (£)
0 2000
50 2500 50 10
100 2700 27 4
150 2850 19 3
200 3000 15 3
250 3250 13 5
300 3900 13 13
350 4550 13 13
400 5600 14 21
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
Changing Marginal Cost as Output Rises

31. Output Total Cost
(£)
Average
Total Cost
(£)
Marginal
Cost (£)
0 2000
50 2500 50 10
100 2700 27 4
150 2850 19 3
200 3000 15 3
250 3250 13 5
300 3900 13 13
350 4550 13 13
400 5600 14 21
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
MC = AC; AC constant
MC = AC; AC constant
Changing Marginal Cost as Output Rises

32. Output Total Cost
(£)
Average
Total Cost
(£)
Marginal
Cost (£)
0 2000
50 2500 50 10
100 2700 27 4
150 2850 19 3
200 3000 15 3
250 3250 13 5
300 3900 13 13
350 4550 13 13
400 5600 14 21
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
MC < AC; AC falling
MC = AC; AC constant
MC = AC; AC constant
MC > AC; AC rising
Changing Marginal Cost as Output Rises

33. Output Total Fixed
Cost (£)
Average
Fixed Cost
(£)
0 2000
50 2000 40
100 2000 20
150 2000
200 2000 10
250 2000
300 2000
350 2000
400 2000 5
Average Fixed Cost Falls as Output Rises

34. Output Total Fixed
Cost (£)
Average
Fixed Cost
(£)
0 2000
50 2000 40
100 2000 20
150 2000
200 2000 10
250 2000
300 2000
350 2000
400 2000 5
Total fixed costs remain constant at each
level of output in the short run
Output (Q)
Cost
TFC
£2000
AFC
As output expands in the short run,
the overhead costs per unit will fall
Output
= 1 unit
Average Fixed Cost Falls as Output Rises

35. MCCost
Output
Rising MC due to
diminishing returns in
the short run
The Shape of Short Run Marginal Cost
Exam technique: Remember to label each axis accurately!

36. MCCost
Output
AC
AC will fall
when
MC < AC
AC will rise
when
MC > AC
Marginal Cost and Average Total Cost

37. MCCost
Output
AC
AC will fall
when
MC < AC
Average cost is at a
minimum when it is
intersected by the
MC curve
AC will rise
when
MC > AC
Marginal Cost and Average Total Cost
Exam technique: MC must cut AC at the minimum point of AC curve

38. MCCost
Output
AC
AVC
MC also cuts AVC
curve at min of AVC
Average variable cost (AVC) is variable cost per unit of
output. The shape of AVC is determined by the shape of
marginal cost – rising MC is due to diminishing returns
MC, AC and Average Variable Cost (AVC)

39. MCCost
Output
AC
AVC
AFC
AFC will fall as
the level of
output
expands
MC also cuts AVC
curve at min of AVC
Average fixed costs must fall continuously as output
increases because total fixed costs are being spread
over a higher level of production.
MC, AC and Average Fixed Cost (AFC)

40. MCCost
Output
AC1
AVC
AC2
A change in fixed costs has no effect on marginal
costs. Marginal costs relate only to variable costs!
Showing a Rise in Fixed Costs

41. MC1Cost
Output
AC1
MC2
AC2
A rise in variable costs of production leads to an
upward shift both in marginal and average total cost
Showing a Rise in Variable Costs

42. The depreciation in sterling is causing a
rise in import prices
This is increasing the variable cost of imported raw materials and
components and the fixed cost of imported capital machinery.

43. Economies of Scale
Long Run Costs and Returns to Scale

44. Internal economies
of scale
Expansion of the firm
itself
Lower long run
average cost (LRAC)
as output increases
External
economies of scale
Expansion of the
industry of which the
firm is a member
Benefits most / all
firms
Internal and External Economies of Scale

45. Internal economies
of scale
Expansion of the firm
itself
Lower long run
average cost (LRAC)
as output increases
External
economies of scale
Expansion of the
industry of which the
firm is a member
Benefits most / all
firms
Internal and External Economies of Scale

46. Internal or External Economy of Scale?
Type your answer in the chat window!
University Science Park
lowers the costs of
research
Small business lowers
their purchasing costs
using a giant wholesaler

47. Internal or External Economy of Scale?
Type your answer in the chat window!
University Science Park
lowers the costs of
research
Small business lowers
their purchasing costs
using a giant wholesaler

48. Internal or External Economy of Scale?
Type your answer in the chat window!
University Science Park
lowers the costs of
research
Small business lowers
their purchasing costs
using a giant wholesaler
External Economy

49. Internal or External Economy of Scale?
Type your answer in the chat window!
University Science Park
lowers the costs of
research
Small business lowers
their purchasing costs
using a wholesaler
External Economy

50. Internal or External Economy of Scale?
Type your answer in the chat window!
University Science Park
lowers the costs of
research
Small business lowers
their purchasing costs
using a wholesaler
External Economy Internal Economy

51. Q1
Average
Cost
(Unit
Cost)
Output
LRAC
Q2 Q3
Economies of scale arise from increasing returns to scale in the long run
Internal Economies of Scale

52. Q1
Average
Cost
(Unit
Cost)
Output
LRAC
Q2 Q3
Economies of
scale cause
AC to fall
Economies of scale arise from increasing returns to scale in the long run
Internal Economies of Scale

53. Q1
Average
Cost
(Unit
Cost)
Output
LRAC
Q2 Q3
Economies of
scale cause
AC to fall
Lowest point on LRAC
is output of
productive efficiency
Economies of scale arise from increasing returns to scale in the long run
Internal Economies of Scale

54. Q1
Average
Cost
(Unit
Cost)
Output
LRAC
Q2 Q3
Economies of
scale cause
AC to fall
Lowest point on LRAC
is output of
productive efficiency
Economies of scale arise from increasing returns to scale in the long run
Rising LRAC – means
diseconomies of scale
Internal Economies of Scale

55. Overview: Impact of Scale Economies
Change: Economies of Scale
Output Higher
Profit maximising price Lower
Total profit Higher
Producer surplus Higher
Consumer surplus Higher
The effect of scale economies is an important aspect to consider
when analysing and evaluating market power
Overview: Impact of Scale Economies

56. Some Key Terms

57. Key Concepts – Short Run Costs
Average Cost
Total cost per unit of output = Total cost /
output = TC/Q
Average Fixed Cost Total fixed cost per unit of output = TFC/Q
Average Variable Cost
Total variable cost per unit of output =
TVC/Q
Diminishing Returns
Addition of a variable factor to a fixed
factor results in a fall in marginal product
Fixed Cost
Business expense that does not vary
directly with the level of output
Marginal cost
The change in total costs from increasing
output by one extra unit
Key Concepts – Short Run Costs

58. Key Concepts – Long Run Costs
Constant returns to scale
When long run average cost (LRAC) remains constant
as output increases because output is rising in
proportion to the inputs used
Diseconomies of scale
A business may expand beyond the optimal size and
see rising Long Run Average Cost (LRAC)
Economies of scope
Where it is cheaper to produce a range of products –
cost savings from product diversification
External economies of scale
When expansion of an industry leads to the growth of
ancillary services causing a downward sloping
industry supply curve
Increasing returns to scale
This means economies of scale, when output is rising
faster than inputs when all inputs can be varied in the
long run
Minimum efficient scale
Where internal economies of scale have been fully
exploited. This corresponds to the lowest point on
the firm’s long run average cost curve (LRAC)
Key Concepts – Long Run Costs

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