Question

e. Plot each of the following curves for the firm on a single diagram.

i. Average variable costs

ii. Average total costs

iii. Marginal costs

iv. Average fixed costs

Illustrate and explain which of the curves will shift, and in which direction, due to a decrease in the cost of labour. Hint: use the definitions of the different costs to assist in determining which costs will change.

Answer 1

Average variable cost (AVC): this is per unit of such cost which varies with production unit; such as material cost, labour cost, etc.

Average total cost (ATC): this is per unit of total cost which includes variable cost and fixed cost both.

Marginal cost (MC): this is the difference of total cost in two successive units of production.

Average fixed cost (AFC): this is per unit of such cost which doesn’t vary with production unit; such as rent, electricity, etc.

Curves are drawn as above. As output increases AFC would be flat because of allocating the same cost in greater units. AVC is downward initially because of economies of scale; once it reaches at the minimum point it starts increasing because of diseconomies of scale. ATC is above these two curves since this is aggregate of AVC and AFC. The curve MC intersects both AVC and ATC at their respective minimum points and goes upward.

Labour cost:

It falls under variable cost, since it depends on per unit of production – suppose rate of wage is $5 for each output.

If such cost decreases, AVC would shift to the left.

Since ATC depends on AVC, it also shifts to the left.

Since MC depends on ATC, it also shifts to the left.

But there will be no change in AFC, since it is unrelated.