Question

1)Given ATC,how would you determine total cost?

a)Graphically show and verbaly explain what the general pattern of and relationship between fixed cost,variable cost and total cost as output increase?

b)Graphically show and verbally explain what the general pattern of and relationship between average total cost,average variable cost and marginal cost as output increases?

Answer 1

(1) Total cost = ATC x Output

(a) Fixed cost (TFC) is constant, therefore is a straight line and is independent of output level. Total variable cost (TVC) varies with output, so it is a straight line starting from origin (if Average variable cost (AVC) is constant) or an inverse-S shaped curve starting from origin (if law of variable proportions applies). Total cost (TC) is sum of TFC and TVC, so it increases with output level. In following graph, law of variable proportions has been assumed and so, both TVC and TC curves are inverse-S shaped.

(b)

AFC = TFC/Q

AVC = TVC/Q

ATC = TC/Q

MC = Change in TC/Change in Q

Therefore, AFC curve falls continuously without touching horizontal axis. Since law of variable proportions is assumed, AVC curve is initially falling, then after reaching the minimum point, is rising. ATC curve too is initially falling, then after reaching the minimum point, is rising. MC curve is initially falling, then after reaching the minimum point, is rising. The MC curve intersects AVC and ATC curves from below, at their minimum points as shown below.