Question

. Answer the following questions briefly, based on your understanding of the common shapes of cost curves.

Where will the marginal cost curve cross the average cost curve? Why?

Will the total cost curve tend to flatten out or to slope up more steeply on the right? Why?

Why are total costs and marginal costs not usually shown on the same graph together?

What are the underlying economic reasons that short-run average cost typically slope down then up?

Will average variable costs usually be above or below average cost? Or will it sometimes be on and sometimes the other? Explain.

Will the marginal cost curve tend to slope up or down? Why?

Why are average costs and fixed costs typically not shown on the same graph together?

How can you tell the level of fixed costs from looking at a total cost curve? What about the level of variable costs?

Answer 1

1) Marginal Cost (MC) Curve will cross the Average Cost Curve (AC) where MC = AC. This happens at the minimum point of the AC curve.

AC is minimized necessarily implies the first derivative of AC = 0 (condition for minimization). What follows is the mathematical proof that when AC is at an extremum: AC = MC as a criteria is satisfied. Only one extremum here i.e. there's a minima, no maxima and so there's a unique criteria.

Economic intuition:

Total Cost = [Fixed Cost + Variable Cost]

=> Average Cost = (Average Fixed Cost) + (Average Variable Cost)

Marginal Cost is the cost of producing an additional unit at the given level of output and, as such, only depends on the Variable Cost component of the firm's business plan.

When the MC < AC, the AC decreases. This is because when the additional unit of output (MC) is cheaper than the average cost per unit (AC), production of the cheaper additional unit pulls down the AC.

Similarly, when the MC > AC, the AC is pushed up.

So when the MC = AC, then the AC neither falls nor rises (i.e. it reaches its minimum).

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2) Total Cost = [Fixed Cost + Variable Cost]

Given regular assumptions like U-shaped MC curve, the Variable Cost component (and so Total Cost also) is first increasing at a decreasing rate (diminishing MC), tapers off (MC minimum) then increases at an increasing rate.

So the answer is neither: the cost curve initially flattens out, has a point of inflection and then slopes up more steeply.

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3) don't have knowledge, sorry

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4) The Short-Run Average Cost Curve slopes down when MC < AC. The cost of each additional unit is less than the average and this pulls down the average with MC further diminishing.

Then, after MC=AC when MC > AC, the cost of each additional unit is greater than the average unit cost at that output level - so the average is pulled up with MC increasing further.

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5)

The Average Fixed Cost (AFC) is generally above the above the AVC initially. For example, if only unit are being produced, Variable Cost Component is for just that one unit whereas a larger lumpsum Fixed Cost is being divided across only 1 unit. But this logic wouldn't be true if Fixed Cost F < MC(0) [MC(0) is the cost of producing the first unit]

So it really depends on the firm's cost structure: whether it's more about a heavy initial investment (e.g. machinery) and comparatively low cost of production for successive units (e.g. flavored soda), or low initial investment (sewing instruments) and comparatively high cost of production for successive inputs (handmade kerchiefs).

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6)

This U shape is directly attributable to the law of diminishing marginal returns which states that adding of additional units of a factor of production results in successively smaller gains in output.

When marginal product (and marginal returns) increases, marginal cost declines. e.g. often four people working together as a team on four projects in sequence will finish the batch faster than one person each assigned one of those four projects. That is, there's some efficiency gain in teamwork.

Then as marginal product (and marginal returns) decreases with the law of diminishing marginal returns for larger than optimal quantities,  marginal cost increases. e.g. "too many cooks spoil the broth", congestion happens which affects efficiency

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7) don't have knowledge, sorry

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8)

The Fixed Cost is the Y-intercept of the total cost curve i.e. TC when x= 0

The Variable Cost is (TC - Fixed Cost) - the VC curve is the TC shifted vertically downwards by the amount of the fixed cost.