Question

explain various types of cost curves in short period with the help of suitable examples.explain the relationship between AC and MC.

Answer 1

Short Run Cost curves are U shaped because of diminishing returns.

In the short run, capital is fixed. After a certain point, increasing extra workers leads to declining productivity. Therefore, as you employ more workers the Marginal Cost increases.

Diagram of Marginal Cost 

Because the short run Marginal cost curve is sloped like this, mathematically the average cost curve will be U shaped. Initially, average costs fall. But, when marginal cost is above the average cost, then average cost starts to rise.

Marginal cost always passes through the lowest point of the average cost curve.

Average Cost Curves

ATC (Average Total Cost) = Total Cost / quantity

AVC (Average Variable Cost) = Variable cost / Quantity

AFC (Average Fixed Cost) = Fixed cost / Quantity


Note FC (fixed costs) remain constant. Therefore the more you produce, the lower the average fixed costs will be.

To work out the marginal cost, you just see how much TC has increased by.

For example, the first unit sees TC increase from 1,000 to 1,200 (therefore the increase (MC) is 200)

For the second unit, TC increases from 1,200 to 1,300 (therefore the increase MC is 100)

Average fixed costs

Long Run Cost Curves

The long-run cost curves are u shaped for different reasons. It is due to economies of scale  and diseconomies of scale. If a firm has high fixed costs, increasing output will lead to lower average costs.

However, after a certain output, a firm may experience diseconomies of scale. This occurs where increased output leads to higher average costs. For example, in a big firm, it is more difficult to communicate and coordinate workers.

Diagram for Economies and Diseconomies of
Note, however, not all firms will experience diseconomies of scale. It is possible the LRAC could just be downward sloping.