Cost Curves

SHAPES OF TOTAL AND AVERAGE COST CURVES

FUNDAMENTAL IDEA:

As Total Product increases at an increasing rate with respect to input (L), that is to say, "increasing marginal returns", Total Variable Cost increases at a decreasing rate with respect to output (Q).

Explanation: If additional labor input yields more than the previous unit of labor (labor is becoming more "productive"), it means that to get an extra unit of output will require less additional labor than the previous unit of output required-- which means that costs, though they will rise, will do so more slowly.

[You can reverse the "less" and the "more" to get the case of accelerating costs:

If additional labor input yields less than the previous unit of labor (labor is becoming less "productive"), it means that to get an extra unit of output will require more additional labor than the previous unit of output required-- which means that costs, will rise and will do so more quickly.]

On a per-unit basis, costs (AVC) will at first decline and then, as "diminishing marginal returns" set in (decreasing marginal product), the MC curve will turn up. Shortly thereafter (at a somewhat larger output Q), the AVC (per unit variable cost) curve will turn up–once the MC curve rises above it. (Remember the relationship between Marginal and Average.) Finally (at a still higher level of production output Q), the ATC curve will turn up, as the increase in "unit variable costs" (AVC) overwhelms the continuing decline in "unit fixed costs."

Remember: the MC curve is a "mirror image" of the MP curve, and the AVC curve is a "mirror image" of the AP curve. Can you explain why?

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This page was last updated on Friday, July 21, 2006.