ECON 1002 Week 7 Short-Run Cost Curve Reading Example

Reading the Short-Run Cost Curves of a One-Stand Bicycle Refurbishing Workshop: Where Marginal Cost Turns Upward, Where It Crosses Each Average and Whether to Stay Open Through a Slow Winter Month

Student Name

Walden University

ECON 1002: Microeconomics

Instructor Name

Month Day, Year

Reading the Short-Run Cost Curves of a One-Stand Bicycle Refurbishing Workshop: Where Marginal Cost Turns Upward, Where It Crosses Each Average and Whether to Stay Open Through a Slow Winter Month

The Workshop

Second Gear is a composite bicycle refurbishing workshop in a small college town. It buys used bicycles, repairs them on a single professional repair stand and resells them. In the short run its fixed costs are rent of $1,800 a month and $200 a month in payments on the stand, a total of $2,000 that must be paid whether or not any bicycles are finished. Its variable costs are mechanic hours and parts. Table 1 gives illustrative monthly costs at eight output levels.

The Cost Table

Table 1

Illustrative Monthly Short-Run Costs at Second Gear

Figures are illustrative. Marginal cost here equals the rise in total cost from one row to the next, spread over the five extra bicycles.

Average total cost falls steeply as fixed costs are spread over more bicycles, bottoms out near thirty a month and then rises as marginal cost climbs.

Figure 1

Average Total Cost per Bicycle at Each Monthly Output Level

Why Marginal Cost Falls and Then Rises

Marginal cost falls from $180 to $120 per bicycle over the first fifteen bicycles. With one mechanic working alone, much time goes to tasks that a second person can share, such as stripping parts while the first adjusts gears. Adding a second mechanic speeds up the work, so each additional bicycle needs fewer extra hours. Beyond about fifteen bicycles, marginal cost rises, reaching $350 for the last five. The reason is the single stand. A third mechanic mostly waits for the stand to be free, so each additional hour of labor adds less output. Marshall (1890) called this tendency the law of diminishing return, and textbooks now call it diminishing marginal returns: when one input is fixed, adding more of a variable input eventually adds less and less to output, which raises the cost of each extra unit (Greenlaw et al., 2022).

Where Marginal Cost Crosses the Averages

Marginal cost crosses average variable cost at about twenty bicycles, where average variable cost is at its lowest, $145. Below twenty, marginal cost is under the average and pulls it down; above twenty, it is over the average and pulls it up. Marginal cost crosses average total cost at about thirty bicycles, where average total cost reaches its minimum of $226.67. The same logic holds: an additional unit that costs more than the current average raises the average. Average total cost bottoms out at a higher output than average variable cost because spreading the fixed $2,000 over more bicycles keeps pushing it down for longer (Mankiw, 2021).

The Winter Decision

In January, demand for refurbished bicycles falls and the going resale price drops to $190. That is below the minimum average total cost of $226.67, so the workshop cannot make a profit at any output this month. Should it close for January?

The short-run shutdown rule says a firm should keep operating whenever the price is at least equal to average variable cost, because revenue then covers all variable costs and contributes something toward fixed costs that must be paid anyway. Here the price of $190 is well above minimum average variable cost of $145, so the rule says stay open.

To choose an output, the workshop produces up to the point where marginal cost reaches the price. Marginal cost is $170 for the block from twenty to twenty-five bicycles and $210 for the next block, so it should finish twenty-five bicycles. The comparison confirms the rule:

- Operating: revenue is 25 x $190 = $4,750; total cost is $5,750; the loss is $1,000.

- Closing: revenue is zero; the $2,000 in fixed costs is still owed; the loss is $2,000.

Operating loses half as much as closing.

Limits of This Reading

The figures are illustrative and grouped in blocks of five, so the crossing points are approximate. The analysis also assumes the workshop can sell all twenty-five bicycles at $190 in January. If it cannot, or if it can store unfinished bicycles and sell them in spring at higher prices, the decision could change. Over a longer period, a second repair stand would shift the whole set of short-run curves.

References

Greenlaw, S. A., Shapiro, D., & MacDonald, D. (2022). Principles of microeconomics (3rd ed.). OpenStax. https://openstax.org/details/books/principles-microeconomics-3e

Mankiw, N. G. (2021). Principles of microeconomics (9th ed.). Cengage Learning.

Marshall, A. (1890). Principles of economics. Macmillan.