Short run cost curves:

Short run is a period of time within which the firms can its output by varying
only the amount of variable factors, such as labor and law materials. In the
short run, fixed factors such as capital equipment, top management etc.
cannot be verified. In other words, in the short run, the firm cannot build a
new plant or abandon an old one. The short run is a period of time in which
only variable factors can be verified, while fixed factors remain the same.
The short-run cost curves are normally based on a production function with
one variable factor of production that displays first increasing and then
decreasing

marginal

productivity.

Increasing

marginal

productivity

is

associated with the negatively sloped portion of the marginal cost curve,
while decreasing marginal productivity is associated with the positively
sloped portion.

100

AC

10

The average fixed cost (AFC) curve is the cost of the fixed factor of
production divided by the quantity of units of the output, while the average
variable cost (AVC) curve cost traces out the per unit cost of variable factor
of production.

Page | 1
Economics: Theory of cost, Revenue and market

The U-shaped average total cost (ATC) curve is derived by adding the
average fixed and variable costs. The marginal cost (MC) intersects both the
AVC and ATC curves at their minimum points. Declining average total costs
are explained as the result of spreading the fixed costs over greater
quantities and, at low quantities, the result of the increasing marginal
productivity, in addition. Increasing average costs occur when the effect of
declining marginal productivity overwhelms the effect of spreading the fixed
costs.
In the short run, all firms have costs that they must bear regardless of
their output. These kinds of costs are called fixed costs. Fixed cost is
any cost that does not depend on the firms level of output.

These

costs are incurred even if the firm is producing nothing.

Variable cost is a cost that depends on the level of production chosen.

Short Run Average Cost Curve:

In the short run, the shape of the average total cost curve (ATC) is U-shaped.
The, short run average cost curve falls in the beginning, reaches a minimum
and then begins to rise. The reasons for the average cost to fall in the
beginning of production are that the fixed factors of a firm remain the same.
The change only takes place in the variable factors such as raw material,
labor, etc.

Page | 2
Economics: Theory of cost, Revenue and market

As the fixed cost gets distributed over the output as production is expanded,
the average cost, therefore, begins to fall. When a firm fully utilizes its scale
of operation (plant size), the average cost is then at its minimum. The firm is
then operating to its optimum capacity. If a firm in the short-run increases its
level of output with the same fixed plant; the economies of that scale of
production change into diseconomies and the average cost then begins to
rise sharply.

Long Run Average Cost Curve / Envelope curve:

Long run average cost curve is known as envelope curve because it is
formed by enveloping the short run average cost curves and it helps the
entrepreneur in long term planning that is why it is also called planning
curve.
In the long run, all costs of a firm are variable. The factors of production can
be used in varying proportions to deal with an increased output. The firm
having time-period long enough can build larger scale or type of plant to
produce the anticipated output. The shape of the long run average cost
curve is also U-shaped but is flatter that the short run curve as is illustrated
in the following diagram:

Page | 3
Economics: Theory of cost, Revenue and market

In the diagram given above, there are five alternative scales of plant SAC1
SAC2, SAC3, SAC4 and, SAC5. In the long run, the firm will operate the scale
of plant which is most profitable to it.

Market:
A market is any place where the sellers of a particular good or service can
meet with the buyers of that goods and service where there is a potential for
a transaction to take place. The buyers must have something they can offer
in exchange for there to be a potential transaction.
Markets include mechanisms or means for:

determining price of the traded item,

communicating the price information,
facilitating deals and transactions, and
effecting distribution.

The market for a particular item is made up of existing and potential

customers who need it and have the ability and willingness to pay for it.

Classification of Market:
On the Basis Of time:
On the basis of time, market can be divided in very short-term, short-term,
long term and very long-term market.
I. Very Short-term Market The market where shortly perishable goods are
sold is called very short-term market. The market of milk, fish, meat, fruits
and other perishable goods is called very short-term market. The price of
short goods is determined according to the pressure of demand. When the
demand for such goods is high, price rises and when demand declines, the
price falls down. If the supply is low and the demand is high, the price rises
higher. In such market supply cannot be increased.
Page | 4
Economics: Theory of cost, Revenue and market

ii. Short term Market

In the short term market, supply of products can be increased using the
maximum capacity of installed machines of the firm. The goods cannot be
produced according to the demand for adjustment of supply by expanding or
changing the existing machines and equipment. In short-term market, price
of the goods is determined on the basis of interaction between demand and
supply. But, as the supply cannot meet the demand, demand affects price
determination in short-term market.
iii. Long term Market
In long-term market, adequate time can be found for supply of products
according to demand. New machines and equipment can be installed for
additional production to meet demand. As supply can be decreased or
increased according to demand situation, price is determined by interaction
between demand and supply in long-term market. Market of durable
products is ling-term market.
Iv. Very Long-term Market or Secular Market
In secular market, produces can get adequate time to use new technology in
production process and bring new changes in products. They become able to
produce and supply goods according to changed needs, interest, fashion etc.
of customers. Market research becomes helpful in doing so.

Page | 5
Economics: Theory of cost, Revenue and market

Perfect Competition:

Large no of sellers & buyers number

Homogeneous products perfectly
Free entry and exit.
Perfect knowledge of price cost (no control over price)
Perfectly price elastic demand imperfect competition.

Imperfect Competition:

Monopoly:
A monopoly or monopolistic market is one that has only one firm (or seller)
that has the autonomy to raise and lower prices without affecting the
demand for its services and products. Monopolies serve the needs of the
sellers but are detrimental to customers. They are characterized by an
absence of economic competition, technological superiority, no substitute for
goods sold and a seller having full control of market power (the ability to
lower and raise the prices without losing clients or customers). Examples of
monopolies include OPEC, public utility companies (water, electricity and
gas) and Internet service providers in remote areas.
Page | 6
Economics: Theory of cost, Revenue and market

Single firm
Perfectly differentiated product without close substitute
Very strong barriers to entry
Extreme control over price
Near to in elastic price elasticity of demand

Duopoly:
Duopoly It is a market where there are only two sellers. A change in the price
and output by one seller affects the other. When a duopolistic takes a
decision, he takes into account the reaction of his rival. The buyers affect
each other's buying action. An example of a duopoly is the U.S. fast food
market, in which a few major buyers (Burger King, McDonald's and Wendy's)
control the meat market

Two sellers
Huge buyers
Non homogeneous product
Restricted entry & exit

Monopsony:
A monopsony is a type of market in which a single powerful buyer controls
and affects market prices. Multiple sellers offer goods and services, but there
is only a single buyer who has exclusive control of market power and can
bring the prices of goods/services down. According to the textbook
"Microeconomics: Principles and Applications," a pure monopsony is rare. An
example of a monopsony is a coal company in a small town.

Large no of sellers and buyers

Differentiated products which are close substitute.
Free entry but firms can produce only close substitutes.
Some control our price.
Less than perfectly price elastic demand.

Oligopoly:
Page | 7
Economics: Theory of cost, Revenue and market

An oligopoly market is characterized by a limited number of competing

sellers who sell similar or different products. Sellers compete with each other
by aggressive advertising and improved service delivery. An oligopoly sets
barriers to entry and makes it difficult for new sellers to enter the market.
Barriers include patent rights, financial requirements and legal barriers.
Tobacco companies, Microsoft, Apple and airlines are oligopolies.
Few producers
Homogenous (Pure Oligopoly) and differentiated but close substitutes
(Differentiated Oligopoly)
Barriers to entry
Small control (Pure Oligopoly) large control (Differentiated Oligopoly)
over price
P.E of D. small (Pure Oligopoly) large (Differentiated Oligopoly)

How equilibrium price & quantity are determined in

a perfectly competitive market structure:
I. MR = MC
II. MC cutes AC from below.

P
MC
Po

AC
MR=AR

Page | 8
Economics: Theory of cost, Revenue and market

Qo

TC= ODOQo
=

Q (out/quantity)

TR = PQ

ODAQo

= OPOQo
=

OPoEQo

= TR TC
=

OPoEQo

DAEPo

IF

ODAQo
or PoEAD

= 0 then it would be Normal Profit

P
MC
B

Po

O
=

Qo

AC
MR=AR

Q (out/quantity)

PoBDC

Loss profit of monopoly market structure:

Page | 9
Economics: Theory of cost, Revenue and market

Tanvi
r.. 121645

Page | 10
Economics: Theory of cost, Revenue and market