Question

Explain short-run cost behavior. AVC, AFC, ATC, MC.

Answer 1

Average fixed cost is the total fixed cost divided by the number of units of output produced. Since total fixed cost is a constant quantity, average fixed cost will steadily fall as output increases.Therefore, average fixed cost curve slopes downward throughout its length. As output increases, the total fixed cost spreads over more and more units and therefore average fixed cost becomes less and less. When output becomes very large, average fixed cost approaches zero.AFC curve gets very nearer to but never touches either axis.If we pick up any point on the average fixed cost curve and multiply the average fixed cost at that point with the corresponding quantity of output produced, then the product is always the same. This is because the product of the average fixed cost and the corresponding quantity of output will yield total fixed cost which remains constant throughout. A curve with such a property is called rectangular hyperbola.It is calculated as

AFC = TFC/Q

Q : number of units of outputs produced

AVC

Average variable cost is the total variable cost divided by the number of units of output pro­duced. The average variable cost will generally fall as output increases from zero to the normal capacity output due to the occurrence of increasing returns.AVC is in U shape because of law of variable proportion..It is calculated as

AVC = TVC/Q

Average Total Cost (ATC):

The average total cost or what is simply called average cost is the total cost divided by the number of units of output produced. Since the total cost is the sum of total variable cost and the total fixed cost, the average total cost is also the sum of average variable cost and average fixed cost. Average total cost is also known as unit cost, since it is cost per unit of output produced

The behaviour of the average total cost curve will depend upon the behaviour of the average variable cost curve and average fixed cost curve.

When AVC curve begins rising, but AFC curve is falling steeply, the ATC curve continues to fall. This is because during this stage the fall in AFC curve weighs more than the rise in the AVC curve. But as output increases further, there is a sharp rise in AVC which more than offsets the fall in AFC.

Therefore the A TC curve rises after a point. Thus, the average total cost curve (ATC) like the A VC curve first falls, reaches its minimum value and then rises. The average total cost curve (ATC) is therefore almost of a ‘U’ shape.

ATC = TC/Q

MC

Marginal cost is addition to the total cost caused by producing one more unit of output. In other words, marginal cost is the addition to the total cost of producing n units instead of n – 1 unit (i.e., one less) where n is any given number.It is worth pointing out that marginal cost is independent of the fixed cost and depends on the changes in the variable factors. Since fixed costs do not change with output, there are no marginal fixed costs when output is increased in the short run.It is only the variable costs that vary with output in the short run. Therefore, the marginal costs are in fact due to the changes in variable costs, and whatever the amount of fixed cost, the marginal cost in unaffected by it.

MC_n = TC_n-TC_n-1

MC = ∆TVC/∆Q

Relationships between MC, AVC, ATC,

When MC is less than AVC, AVC falls with increase in the output.

When MC is equal to AVC, i.e. when MC and AVC curve intersect each other , AVC is constant and at its minimum point

When MC is more than AVC, AVC rises with increase in output

therefore both MC and AVC rises, but MC rise increases at faster rat as compared to AVC. As a result MC curve is steeper as compared to AVC curve.

Both MC and AVC curve are in u shape because of law of variable Proportion.

When MC is less than ATC and AVC, both of the falls with increase in the output

When MC become equal to AC and AVC, they become constant. MCcurve cuts AC Curve and AVC curve at their minimum point

When MC is more than AC and AVC, both rises with increase in output.