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iii) Total Cost Curves: Let us begin with a picture of Total Cost, Total Fixed Cost and Total Variable Cost Curves. This is simpler and easier to understand. With increasing units of output: 4, 11, 18, 23, 25 and 26, Total Fixed Cost remains constant at $40. Total Variable Cost increases proportionately as 10, 20, 30, 40, 50 and 60. The Total Cost as a sum of the two (Total Fixed and Total Variable Costs) increases as 50, 60, 70, 80, 90 and 100. In the figure three cost curves have been drawn accordingly.

Total Output Units have been measured along the horizontal axis and Total Costs have been shown on the vertical axis. At a distance of 40 units we find T - FC as a line parallel to OX axis. This shows that even at zero output level TC is equivalent to FC. From here onwards TC rises continuously and in the same proportion as VC. Therefore VC and TC are parallel curves.

iv) Marginal, AVC, AFC, ATC, curves: Let us now turn to the slightly complex nature of the marginal and average cost curves.

a) Marginal and Average Cost Curves: In Figure 29 we have once again shown varying output units on the horizontal axis and different cost amounts on the vertical axis. All the four cost curves have been drawn on the basis of respective values in the tables above. Marginal Cost varies as 2.5, 1.42, 1.42, 2.0, 5.0 and 10.0. Accordingly the Marginal Cost Curve has been drawn. It shows an initial downward trend but a subsequent sharp rise. AFC is based on the values 10, 3.63, 2.22, 1.73, 1.60, 1.54 therefore it is seen to be continuously falling. However, initially it falls sharply and then with a slower tempo. AFC first falls sharply and then its curve becomes flatter. AVC is based on the cost values 2.5, 1.82, 1.67, 1.73, 2.0 and 2.33. Therefore AVC initially falls moderately and then it rises continuously but moderately. Since ATC is combination of both AFC and AVC, it has a mixed behavior. It is based on the values 12.5, 5.45, 3.89, 3.46, 3.60 and 3.80. The behavior of ATC is to be explained in terms of the joint behavior of AFC and ATC. It is necessary to analyze ATC more carefully. Let us workout its features.

b) Behavior of ATC: Certain features of the ATC are worth analyzing. These are as follows:

  • ATC shows three distinct phases. Between C1C2 the curve slopes downward. At C2 the curve reaches a minimum point. From C2 to C3 the curve starts continuously rising upwards. It is also called Short Run (SAC) ’U’ Shaped Cost Curve.

  • The two components of ATC are noticeable. At output level Q1 value of ATC = C1Q1 which is equal to F1Q1 the Fixed Cost Component and V1Q1 the Variable Cost Component. This is true for any point on ATC.

C1Q1 = F1Q1 + V1Q1

  • The lowest point on ATC is C2. Around this point ATC remains constant for a moment. To the left of C2 ATC falls (C1C2) and to its right ATC rises (C2C3). ATC thus shows the three stages of cost behavior, namely, the Diminishing, the Minimum (Constant) and the Increasing Cost Phases.

  • The lowest point on ATC is C2 2 the point of Minimum, the Marginal Cost Curve MC intersects ATC. This is essential since MC is in addition to Variable Cost. So long as MC rises but remains below ATC the ATC falls. When MC crosses ATC and is above ATC it causes a rise in the value of ATC as well as an upward shift in the curve.

c)Causes of ATC behavior: ATC passes through three stages. Initially it falls, then it reaches a minimum and is nearly constant; finally it starts increasing. The explanation of such behavior of the ATC runs is as in the case of the laws of variable returns. In the short run, internal economies such as better and efficient performance of machine and manager, better supervision and avoidance of waste, etc. are examples of internal economies. The shape of ATC also depends on the different nature of the fixed and variable inputs. So long as fixed and indivisible factors are not used to their fullest capacity (C1C2) the ATC keeps on falling. Once the fixed capacity is fully utilized the ATC reaches a minimum point (C2). This is the point of optimum utilization of fixed factors. If the output continues to increase beyond this point the fixed factors get over utilized and cause ATC to rise.

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9.1 - Concept of a Firm
9.2 - Factors of Production and Product Output
9.3 - Costs and Profits
9.4 - Costs Analysis

Chapter 10

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