Question

II.We discussed the following table in the lecture/presentation. Just for your own practice, try filling out the columns for each:

Quantity Fixed Cost Variable Cost Total Cost Average Fixed Cost   Average Variable Cost   Average Total Cost Marginal Cost
1 100 10

2 100 15

3 100   25

4 100   40

5 100 60

6 100 85

7 100 115

8 100 150

9 100 190

10 100 235

Following are the questions you should be able to answer:

1.What happens to Average Fixed Cost as quantity increases?
2.What happens to Average Variable Cost as quantity increases?
3.What happens to Average Total Cost as quantity increases?
4.What is the distance between Average Variable Cost and Average Total Cost?
5.What is the shape of Average Total Cost? Why is it shaped that way? (In other words, what is going on until Q=7? What happens after Q=7?)
6.What is the relationship between Marginal Cost and Average Total Cost?
7.What is the relationship between Marginal Cost and Average Variable Cost?
8.What happens to Average Total Cost in the Long Run? What is the shape? Why?

Answer 1

1. AFC decreases with the increase in quantity.

2. Initially AVC decreases with the increase in quantity and after certain point it starts increasing.

3. Initially ATC decreases with the increase in quantity and after certain point it starts increasing.

4. ATC - AVC = AFC

Difference between average total cost and average variable cost is average fixed cost.

5. The shape of average total cost curve is in U shape.

The ATC curve is U in shape because with increase in quantity the efficiency of input increases. That is increasing returns to scale the cost per unit decreases.

Upto 7th unit the firm faces increasing returns to scale.

6.When the ATC increases, the marginal cost is greater than the average cost. When the average cost stays the same, MC = ATC.

7. When AVC is minimum it is equal to MC.

8. In the long run the firm faces an ATC which is U in shape. This is due to economies of scale.