Understand the terms associated with the short-run production function-total product, average product, and marginal product-and explain and illustrate how they are related to each other.

Note that here the lowest possible supply level ( X) changes because variable costs increase. Remaining firms will keep producing the same quantity of goods. The market production costs will increase causing a contraction in supply, and thus firms exiting the market. When variable costs increase, they cause an upward shift in the marginal and average cost curves. It must be noted that the lowest possible supply level ( X) remains unchanged because variable costs remain unchanged. However, because some firms exit the market, quantity produced by remaining firms will increase. Since there is a shift in demand to the left, less total quantity will be sold.

This contraction will cause an increase in price that eventually will result in a decrease in the demand for the product. If a firm has an increase in its costs, it can easily result in losses that will cause it to exit the market, and thus motivate a contraction on supply. Increases in fixed costs automatically imply an increase in average total cost. If fixed costs increase but the initial market equilibrium is still maintained on the point in which average costs used to be at its lowest ( A), the firm will incur in losses. This analysis must be done in the long term, since long run cost analysis considers changes in both variable and fixed costs, and allows the entry and exit of firms to and from the market. Once the differences between fixed and variable, and average and marginal costs are understood, it’s interesting to use comparative statics in order to see how new, higher costs may vary the firm’s cost structure, as well as the market structure as a whole.

New costs will modify a firm’s equilibrium quantity and price. The price of an essential input for the production or the cost of rent may inevitably change. Firms’ cost structures will change over time, even when the quantity produced is kept constant.

Cost curve perfect competition shift