Question

What shapes would you generally expect each of the following cost curves to have: fixed costs, variable costs, marginal costs, average total costs, and average variable costs?

Short answer

Fixed costs (FC) curve is horizontal, as these costs do not change with production. Variable costs (VC) curve slopes upward with an increasing slope, since costs change with the level of production. Marginal costs (MC) curve is U-shaped, initially decreasing, reaching a minimum, and then increasing due to efficiencies, diminishing returns, and resource constraints. Average total costs (ATC) curve is also U-shaped, initially decreasing and then increasing, representing the interplay of fixed and variable costs. Average variable costs (AVC) curve has a U-shape similar to MC, but does not account for fixed costs.

Step-by-step solution

1. Fixed Costs (FC)

Fixed costs are costs that do not change with the level of production. These can include costs such as rent, insurance, or salaries that must be paid regardless of the number of units that are produced. The fixed cost curve is a horizontal line since these costs do not change with production.

2. Variable Costs (VC)

Variable costs are costs that change with the level of production. Examples of variable costs are raw materials, labor, and utilities, which typically increase as more units are produced. The variable cost curve generally slopes upward with an increasing slope. This is because, as production increases, it may be necessary to use more expensive resources (such as labor or machinery) to maintain the same production level.

3. Marginal Costs (MC)

Marginal costs are the cost of producing one additional unit of a good or service. This curve typically has a U-shape, initially decreasing, reaching a minimum point, and then increasing. It decreases at first due to specialization and economies of scale. As production increases, it reaches a minimum point where efficiency is maximized, and then increases due to diminishing returns and the need for more expensive resources to maintain production levels.

4. Average Total Costs (ATC)

Average total costs are the total costs divided by the number of units produced. It is the sum of average fixed costs and average variable costs. The average total cost curve also has a U-shape, initially decreasing and then increasing. The curve decreases when the reductions in average fixed costs (due to spreading these costs over a larger number of units) outweigh the increase in average variable costs (due to resource constraints). Then, the curve increases when average variable costs dominate, driven by rising production costs and diminishing returns.

5. Average Variable Costs (AVC)

Average variable costs are the variable costs divided by the number of units produced. This curve shares similarities with the marginal cost curve, having a U-shape and initially decreasing due to specialization and efficiencies in production. The average variable cost curve then increases when diminishing returns set in, and producing additional units becomes more expensive. However, unlike the marginal cost curve, the average variable cost curve does not directly account for fixed costs.