Cost Curves in Economics
Cost curves represent the relationship between output and different types of costs incurred by a firm in the short run and long run. These curves help in understanding production decisions and pricing strategies in economics.
Types of Cost Curves
a) Short-Run Cost Curves: In the short run, some factors of production are fixed, and firms face the following cost curves:
Total Cost (TC) Curve
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- It represents the sum of Total Fixed Cost (TFC) and Total Variable Cost (TVC).
- Formula: TC = TFC + TVC
- The TC curve starts from the TFC level and increases as output increases.
Total Fixed Cost (TFC) Curve
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- Fixed costs remain constant regardless of output (e.g., rent, machinery).
- The TFC curve is a horizontal straight line since it does not change with output.
Total Variable Cost (TVC) Curve
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- Variable costs change with output (e.g., wages, raw materials).
- The TVC curve starts from the origin and rises as production increases.
Average Cost Curves
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- Average Fixed Cost (AFC) = TFC / Q: AFC declines as output increases (spreading overhead).
- Average Variable Cost (AVC) = TVC / Q: AVC first decreases, then rises due to diminishing returns, forming a U-shape.
- Average Total Cost (ATC) = TC / Q or AVC + AFC: ATC follows a U-shape because of economies and diseconomies of scale.
Marginal Cost (MC) Curve
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- MC = Change in TC / Change in Q
- It measures the additional cost of producing one more unit of output.
- The MC curve intersects AVC and ATC at their minimum points.
b) Long-Run Cost Curves: In the long run, all inputs are variable, and firms can adjust production fully. The key cost curves include:
- Long-Run Average Cost (LRAC) Curve
- It is derived from multiple short-run ATC curves.
- It is U-shaped due to economies of scale (cost advantages due to expansion) and diseconomies of scale (rising costs due to inefficiencies).
- Long-Run Marginal Cost (LRMC) Curve
- Represents the additional cost of producing one more unit in the long run.
- It intersects LRAC at its minimum point.
Key Insights from Cost Curves
- AFC always declines as output increases.
- MC influences ATC and AVC—when MC < ATC, ATC falls; when MC > ATC, ATC rises.
- LRAC is flatter than short-run ATC due to flexibility in input adjustments.
- U-shaped cost curves occur due to economies and diseconomies of scale.
