Question

Explain the relationship of varying output with total fixed cost (TFC), total variable cost (TVC), average fixed cost (AFC), average variable cost (AVC) and average total cost (ATC).

Answer 1

Output and total fixed costs( TFC)-

Total fixed costs are the costs incurred on the use of fixed factors of production. Total fixed costs do not change with a change in the level of output. It is independent of the output produced. It remains constant regardless of the output produced. Hence, when output increases, total fixed costs remain the same ( constant) at every level of output.

Output and total variable cost( TVC)-

Total variable cost is the cost incurred on the use of variable factors of production. As output increases, variable factor also increases and hence, total variable cost also increases throughout. But, as output increases, total variable cost Initially increases at a decreasing rate and subsequently it increases at an increasing rate . Initially the amount of variable factor is small as compared to the fixed factor. When the amount of variable factor is increased, fixed factor is better utilised. Hence, total variable cost increases at a decreasing rate. When the amount of variable factor becomes too large, overcrowding occurs around the fixed factor resulting in over utilisation of the fixed factor and as such total variable cost increases at an increasing rate.

Output and average fixed cost( AFC)-

Average fixed cost is the per unit cost of the fixed factors of production. As output increases, average fixed cost falls throughout. This is because as output increases, total fixed cost ( which remains constant at all levels of output) is spread over larger and larger units . For very small output, average fixed cost is high and for large output, average fixed cost is low.

Output and average variable cost( AVC)-

Average variable cost is per unit cost of variable factors of production. As output increases, average variable cost falls first, reaches the minimum and then increases.  Initially the amount of variable factor is small as compared to fixed factor. When amount of variable factor is increased fixed factor is better utilised resulting in the efficiency of variable factor and hence average variable cost decreases. When the amount of variable factor becomes too large in relation to the fixed factor, fixed factor is fully utilised and efficiency of variable factor declines. Hence, average variable cost increases.

Output and average total cost( ATC)-

Average total cost is per unit cost of both fixed and variable factors of production. As output increases, average total cost declines first, reaches the minimum and then increases. Initially the amount of fixed factor is large and that of variable factor is small. As the amount of variable factor is increased, fixed factor is better utilised resulting in a decrease in average total cost. As the amount of variable factor goes on increasing, the amount of variable factor becomes too large in relation to the amount of fixed factor and overcrowding of variable factor occurs. As such fixed factor is over utilised and hence average total cost increases.