Marginal and average cost curves, Managerial Economics

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Relationship between AC, AVC, AFC and MC is elucidated graphically by drawing respective cost curves in Figure below. Behaviour of cost curves is elucidated below.

1873_Marginal and Average Cost Curves.png

Figure: Marginal and Average Cost Curves

Because AFC is falling steadily as output increases, AFC curve is also falling steadily from left to right. Mathematically, AFC curve approaches both axes, which is, it gets very near to though never touches either axis. Because we are dividing the constant fixed cost by different levels of output, AFC curve is a rectangular hyperbola. This refers that if we multiply AFC at any point on AFC curve with corresponding quantity of output, we would always get the same total fixed cost. This property of the AFC curve demonstrates that TFC is constant throughout.

AVC curve falls initially, reaches a minimum and then rises as output increases. It falls slowly as the firm's output rises from zero to normal capacity level. Once normal capacity output is reached AVC curve rises sharply with the increase in output. This is due to the fact that use of more and more of the variable factors, say labour, will result in overcrowding and also to problems of organisation. Further, as the existing fixed factors are employed more intensively machines will breakdown more often. All these lead to sharp increase in AVC.


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