(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 317

292 PART 2 • Producers, Consumers, and Competitive Markets
Let’s calculate average variable cost and marginal cost
for the first 80 units of output and then see how both
cost measures change when we include the additional
20 units produced with overtime labor. For the first 80
units, average variable cost is simply the labor cost
($2400 ϭ $30 per unit ϫ 80 units) plus the materials
cost ($640 ϭ $8 per unit ϫ 80 units) divided by the
80 units—($2400 ϩ $640)/80 ϭ $38 per unit. Because
average variable cost is the same for each unit of output, marginal cost is also equal to $38 per unit.
When output increases to 100 units per day, both
average variable cost and marginal cost change.
The variable cost has now increased; it includes
the additional materials cost of $160 (20 units ϫ
$8 per unit) and the additional labor cost of $1000
(20 units ϫ $50 per unit). Average variable cost is
therefore the total labor cost plus the materials cost
($2400 ϩ $1000 ϩ $640 ϩ $160) divided by the
100 units of output, or $42 per unit.
What about marginal cost? While the materials cost
per unit has remained unchanged at $8 per unit, the
marginal cost of labor has now increased to $50 per
unit, so that the marginal cost of each unit of overtime
output is $58 per day. Because marginal cost is higher
than average variable cost, a manager who relies on
average variable cost will produce too much.
Second, a single item on a firm’s accounting ledger may have two components, only one of which

involves marginal cost. Suppose that a manager
is trying to cut back production. She reduces the
number of hours that some employees work and

lays off others. But the salary of an employee who
is laid off may not be an accurate measure of the
marginal cost of production when cuts are made.
Union contracts, for example, often require the firm
to pay laid-off employees part of their salaries. In
this case, the marginal cost of increasing production is not the same as the savings in marginal cost
when production is decreased. The savings is the
labor cost after the required layoff salary has been
subtracted.
Third, all opportunity costs should be included in
determining marginal cost. Suppose a department
store wants to sell children’s furniture. Instead of
building a new selling area, the manager decides
to use part of the third floor, which had been used
for appliances, for the furniture. The marginal cost
of this space is the $90 per square foot per day in
profit that would have been earned had the store
continued to sell appliances there. This opportunity
cost measure may be much greater than what the
store actually paid for that part of the building.
These three guidelines can help a manager to
measure marginal cost correctly. Failure to do so
can cause production to be too high or too low and
thereby reduce profit.

8.5 The Competitive Firm’s Short-Run
Supply Curve
A supply curve for a firm tells us how much output it will produce at every possible price. We have seen that competitive firms will increase output to the point
at which price is equal to marginal cost, but will shut down if price is below
average variable cost. Therefore, the firm’s supply curve is the portion of the marginal cost curve for which marginal cost is greater than average variable cost.

Figure 8.6 illustrates the short-run supply curve. Note that for any P greater
than minimum AVC, the profit-maximizing output can be read directly from
the graph. At a price P1, for example, the quantity supplied will be q1; and at P2,
it will be q2. For P less than (or equal to) minimum AVC, the profit-maximizing
output is equal to zero. In Figure 8.6 the entire short-run supply curve consists
of the crosshatched portion of the vertical axis plus the marginal cost curve
above the point of minimum average variable cost.
Short-run supply curves for competitive firms slope upward for the same reason that marginal cost increases—the presence of diminishing marginal returns to
one or more factors of production. As a result, an increase in the market price will
induce those firms already in the market to increase the quantities they produce.