No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seven: Production: Man at Work 165 SHORT RUN COSTS Let’s review our discussion on time from chapter 4. For our analysis, we will consider three time periods: market period, short run, and long run. § § Market Period : No production inputs can be changed, they are all fixed. Supply cannot adjust in the face of changing demand. § § Short Run : At least one production input can be changed, but not all inputs. § § Long Run : All production inputs can be changed—they are all variable. The entrepreneur has to calculate the best mix of resources to produce a certain level of output, and some asset costs are different than others. As we discussed, an entrepreneur will try to reduce costs to maximize profits. The total costs that an entrepreneur wants to minimize can be divided into fixed costs and variable costs: Total Cost ( TC ) = Fixed Costs ( FC ) + Variable Costs ( VC ) TC = FC + VC or In the short run, as we’ve defined, not all inputs are variable—some are fixed. For example, let’s say the C8 Corvette continues to be a huge hit in 2021 after its successful introduction in 2020. In the short run, fixed costs would include the number of factories; it might take a couple of years to bring a totally new factory online, and it might still take 6-12 months to reconfigure another production line (say from the Camaro) to produce additional Corvettes. Perhaps the only variable might be labor; GM could either hire other workers and run multiple shifts, or perhaps expand overtime usage (if they thought the increased demand was only temporary). Since fixed costs are fixed , they are the same regardless of quantity. For example, if you produce more cars through the physical plant, the insurance cost for the building will stay the same. Likewise, if you totally shut down production you still have to pay the insurance cost. Variable costs such as labor vary with output quantity and increase as more output is produced. Figure 7.7 shows the relationship between total costs, fixed costs, and variable costs. Figure 7.7, Total Cost Curves. Total fixed costs do not vary with output and thus are constant in the short run, like property taxes on a factory. Variable costs will rise as output increases per the graph above. An entrepreneur may hire additional workers or add more capital equipment. The variable cost curve shape reflects initial gains from specialization as costs rise more slowly than output, but eventually, diminishing returns causes costs to rise faster than output. The difference between variable cost and total cost by definition is the number of fixed costs, which is constant across the curves, as indicated by the size of the arrows. Output (Q) Total Cost Curves Costs ($) TC TVC TFC