Question

b. What determines AVC?

Explain what AVC depends on.

Why would a firm want to know AVC?

Explain how a firm uses AVC.

Answer 1

The Shape of MC is U shape, it means initially MC decreases with the increase in the output and after production of some output, the MC become minimum and after this MC starts increasing.

AVC is U shaped in the short-run because it initially decreases with the decreases in the MC when MC is less than AVC, but when MC is greater than AVC, then AVC starts rising. Hence AVC has U shape.

Shut-down condition is

P=MC=minimum of AVC

AVC=TVC/Q

Total variable cost is sum of all MC costs.

It means AVC is determined by the quantity of output and total variable cost and TVC is influenced by the MC.

It means AVC depends on quantity and MC.

A firm wants to know the AVC for determining shut-down condition, so with the equality of the AVC and MC, the shut-down price are determined.

Hence based on this firm determines whether to operate in the short-run or shut-down.

When price is greater than the minimum value of the AVC, then firm is earning more than the total variable cost, so firm should continue to produce in the short-run.

When price is less than the minimum value of the AVC, then firm is earning less than the total variable cost, so firm should shut-down in the short-run.