Question

Q2. Distinguish between average fixed cost and average variable cost diagrammatically. Explain why the short run cost curve is U shaped.
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Answer 1

ᴛʜᴇ ᴅɪғғᴇʀᴇɴᴄᴇ ʙᴇᴛᴡᴇᴇɴ ᴀᴠᴇʀᴀɢᴇ ᴛᴏᴛᴀʟ ᴄᴏsᴛ ᴀɴᴅ ᴀᴠᴇʀᴀɢᴇ ᴠᴀʀɪᴀʙʟᴇ ᴄᴏsᴛ ɪs ᴀᴠᴇʀᴀɢᴇ ғɪxᴇᴅ ᴄᴏsᴛ. ᴀᴠᴇʀᴀɢᴇ ғɪxᴇᴅ ᴄᴏsᴛ ᴅᴇᴄʀᴇᴀsᴇs ᴀs ᴏᴜᴛᴘᴜᴛ ɪɴᴄʀᴇᴀsᴇs, sᴏ ᴛʜᴇ ᴅɪғғᴇʀᴇɴᴄᴇ ʙᴇᴛᴡᴇᴇɴ ᴀᴠᴇʀᴀɢᴇ ᴛᴏᴛᴀʟ ᴄᴏsᴛ ᴀɴᴅ ᴀᴠᴇʀᴀɢᴇ ᴠᴀʀɪᴀʙʟᴇ ᴄᴏsᴛ ᴍᴜsᴛ ᴀʟsᴏ ᴄᴏɴᴛɪɴᴜᴏᴜsʟʏ ᴅᴇᴄʀᴇᴀsᴇ. ᴀᴛᴄ = ᴀᴠᴄ + ᴀғᴄ , sᴏ ᴀᴛᴄ − ᴀᴠᴄ = ᴀғᴄ

ᴄᴏsᴛs ɪɴ ᴛʜᴇ sʜᴏʀᴛ ʀᴜɴ

sʜᴏʀᴛ ʀᴜɴ ᴄᴏsᴛ ᴄᴜʀᴠᴇs ᴛᴇɴᴅ ᴛᴏ ʙᴇ ᴜ sʜᴀᴘᴇᴅ ʙᴇᴄᴀᴜsᴇ ᴏғ ᴅɪᴍɪɴɪsʜɪɴɢ ʀᴇᴛᴜʀɴs. ɪɴ ᴛʜᴇ sʜᴏʀᴛ ʀᴜɴ, ᴄᴀᴘɪᴛᴀʟ ɪs ғɪxᴇᴅ. ᴀғᴛᴇʀ ᴀ ᴄᴇʀᴛᴀɪɴ ᴘᴏɪɴᴛ, ɪɴᴄʀᴇᴀsɪɴɢ ᴇxᴛʀᴀ ᴡᴏʀᴋᴇʀs ʟᴇᴀᴅs ᴛᴏ ᴅᴇᴄʟɪɴɪɴɢ ᴘʀᴏᴅᴜᴄᴛɪᴠɪᴛʏ. ᴛʜᴇʀᴇғᴏʀᴇ, ᴀs ʏᴏᴜ ᴇᴍᴘʟᴏʏ ᴍᴏʀᴇ ᴡᴏʀᴋᴇʀs ᴛʜᴇ ᴍᴀʀɢɪɴᴀʟ ᴄᴏsᴛ ɪɴᴄʀᴇᴀsᴇs

Answer 2

Answer:

The addition of fixed and Variable Cost gives us total costs, which when divided by the output give us Average Costs in the short period.

The nature of short period Average Cost Curve is ‘U’ shaped. To begin with, the Average Costs are high at low levels of output because both the Average Fixed Costs and Average Variable Costs are more.

But, as the level of output increases, the Average Costs fall more sharply due to the combined effect of the declining average fixed and Average Variable Costs.

This results from the use of indivisible factors and the reaping of internal economies of labour, technical, managerial, marketing etc. The Average Cost will continue to fall till they reach the minimum point which is the optimum point level of output. Once the optimum level of output is reached, Average Costs starts rising as more are produced beyond this level.

The rise in Average Variable Cost is more than off set by the small fall in Average Fixed Costs and hence the Average Costs rises quickly. This is due to the change of economies into dis-economies. This gives the short-run as well as long-run Average Cost Curve of the firm IP shaped.