Skip to content Home Why is the average cost curve U shaped? Ben Davis May 29, Why is the average cost curve U shaped? Which of the following cost curve is U shaped? How is the U-shape of average variable cost explained by the law of variable proportions? Why does MC cut AC at its minimum? What is AVC at its minimum? What is AVC curve? How is fixed cost curve? Why is AFC called a hyperbola? Which curve is not affected by fixed cost? What is total fixed cost curve? How do you classify costs? What is basic cost concept?
What kind of cost is rent? Is rent a debit or credit? What type of cost is raw materials? What is direct cost example? What are examples of indirect costs? The economies of scale curve is a long-run average cost curve, because it allows all factors of production to change. Short-run average cost curves assume the existence of fixed costs, and only variable costs were allowed to change. One prominent example of economies of scale occurs in the chemical industry.
Chemical plants have a lot of pipes. The cost of the materials for producing a pipe is related to the circumference of the pipe and its length. However, the volume of chemicals that can flow through a pipe is determined by the cross-section area of the pipe. The calculations in Table 1 show that a pipe which uses twice as much material to make as shown by the circumference of the pipe doubling can actually carry four times the volume of chemicals because the cross-section area of the pipe rises by a factor of four as shown in the Area column.
A doubling of the cost of producing the pipe allows the chemical firm to process four times as much material. This pattern is a major reason for economies of scale in chemical production, which uses a large quantity of pipes. Of course, economies of scale in a chemical plant are more complex than this simple calculation suggests.
While in the short run firms are limited to operating on a single average cost curve corresponding to the level of fixed costs they have chosen , in the long run when all costs are variable, they can choose to operate on any average cost curve.
Thus, the long-run average cost LRAC curve is actually based on a group of short-run average cost SRAC curves , each of which represents one specific level of fixed costs.
More precisely, the long-run average cost curve will be the least expensive average cost curve for any level of output. Figure 3 shows how the long-run average cost curve is built from a group of short-run average cost curves. Five short-run-average cost curves appear on the diagram. Each SRAC curve represents a different level of fixed costs. Think of this family of short-run average cost curves as representing different choices for a firm that is planning its level of investment in fixed cost physical capital—knowing that different choices about capital investment in the present will cause it to end up with different short-run average cost curves in the future.
Figure 3. Other SRAC curves, not shown in the diagram, lie between the ones that are shown here. The long-run average cost LRAC curve shows the lowest cost for producing each quantity of output when fixed costs can vary, and so it is formed by the bottom edge of the family of SRAC curves.
The long-run average cost curve shows the cost of producing each quantity in the long run, when the firm can choose its level of fixed costs and thus choose which short-run average costs it desires. The average total cost curve is typically U-shaped.
Average variable cost AVC is calculated by dividing variable cost by the quantity produced. The average variable cost curve lies below the average total cost curve and is typically U-shaped or upward-sloping. Marginal cost MC is calculated by taking the change in total cost between two levels of output and dividing by the change in output. The marginal cost curve is upward-sloping. Average variable cost obtained when variable cost is divided by quantity of output.
Note that at any level of output, the average variable cost curve will always lie below the curve for average total cost, as shown in Figure 1. The reason is that average total cost includes average variable cost and average fixed cost. However, as output grows, fixed costs become relatively less important since they do not rise with output , so average variable cost sneaks closer to average cost.
Average total and variable costs measure the average costs of producing some quantity of output. Marginal cost is somewhat different. Recall that marginal cost, which we introduced on the previous page, is the additional cost of producing one more unit of output. So it is not the cost per unit of all units being produced, but only the next one or next few. Marginal cost can be calculated by taking the change in total cost and dividing it by the change in quantity.
For example, as quantity produced increases from 40 to 60 haircuts, total costs rise by — , or The marginal cost curve may fall for the first few units of output but after that are generally upward-sloping, because diminishing marginal returns implies that additional units are more costly to produce. A small range of increasing marginal returns can be seen in the figure as a dip in the marginal cost curve before it starts rising.
Watch this video to learn how to draw the various cost curves, including total, fixed and variable costs, marginal cost, average total, average variable, and average fixed costs. The reason why the intersection occurs at this point is built into the economic meaning of marginal and average costs. If the marginal cost of pro duction is below the average total cost for producing previous units, as it is for the points to the left of where MC crosses ATC, then producing one more additional unit will reduce average costs overall—and the ATC curve will be downward-sloping in this zone.
Conversely, if the marginal cost of production for producing an additional unit is above the average total cost for producing the earlier units, as it is for points to the right of where MC crosses ATC, then producing a marginal unit will increase average costs overall—and the ATC curve must be upward-sloping in this zone. The same relationship is true for marginal cost and average variable cost.
The reasoning is the same also.
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