Shapes of the Short Run Cost Curves – Part 2

Shape of the Average Fixed Cost (AFC) Curve and Short Run Marginal Cost (SMC) Curve

In part 1 of the Shape of Short Run Cost Curves, we discussed in detail regarding shapes of Total Fixed Cost (TFC), Total Variable Cost (TVC), and Total Cost (TC).

As we know in the short run, firm has at least few factors of production or inputs which remain fixed or constant irrespective of the level of output produced by the firm. The cost incurred by the firm to employ such fixed or constant factors of production is known as Total Fixed Cost. And the rest of the factors of production are variable with the output level produced. The cost incurred by the firm to employ such variable factors of production is known as Total Variable Cost. The addition of Total Fixed Cost and Total Variable Cost gives Total Cost incurred by the firm to employ all the factors of production or inputs or resources.

As in the short run, firm cannot change or alter the fixed factors of production, so in order to achieve the desired level of output, the firm alter the variable factors of production in the short run. Thus as the firm increases the output in the short with increased employment of variable factors of production, the Total Variable Cost (TVC) too increases. And as the Total Variable Cost (TVC) is a part of the Total Cost, the increase in output or production level also results in increase in the Total Cost. So to say, as the output increases in the short run, the Total Variable Cost (TVC) as well as Total Cost (TC) both increases while the fixed cost remains fixed or constant in the short run irrespective of increasing or decreasing output. 

The below graphical representation shows the shapes of the above Cost Curves.

The above graph depicts cost curves for Total Fixed Cost (TFC), Total Variable Cost (TVC), and Total Cost (TC). On the x-axis, the output produced by the firm is shown and on the y-axis all the short run costs curves are shown. We can see the Total Fixed Cost (TFC) curve is a horizontal line denoting that even as the level of output on x-axis keeps increasing, the fixed costs remain the same. Even if the output level comes down to 0, the firm will incur fixed costs. The TFC curve meets the y-axis at C1 showing the amount of fixed cost incurred by the firm.

The second is the Total Variable Cost (TVC) Curve which increases simultaneously with the level of output. As the output increases, the variable costs incurred by the firm too increases. The Total Variable Cost curve meets the y-axis at C2, showing the amount of variable costs incurred by the firm.

Lastly, comes the Total Cost curve which increases with level of output thanks to increasing variable cost component of the Total Cost. Total Cost includes both the costs fixed and variable and hence is the sum of them. The Total Cost (TC) curve meets the y-axis at C3 showing the amount of total costs incurred by the firm to carry out the desired level of output or production.

Average Fixed Cost Curve 

Average Fixed Cost is simply fixed cost incurred by the firm per unit of output. The Average Fixed Cost for a firm can be derived by dividing the Total Fixed Cost (TFC) with Total Output (q).

So we can say that Average Fixed Cost is the ratio of Total Fixed Cost to output. Now we know that the Total Fixed Cost is constant or fixed. Therefore, as the output increases, the Average Fixed Cost decreases. At the same time, if the output is near to 0, the Average Fixed Cost is arbitrarily very large. When the output approaches infinity, the Average Fixed Cost approaches 0. The shape of Average Fixed Cost is a Rectangular Hyperbola.

On multiplying any quantity of output (q) with the corresponding Average Fixed Cost (AFC), we always get the constant i.e., Total Fixed Cost (TFC). 

The below graph shows the common Average Fixed Cost Curve for a firm.

The above graph shows the Average Fixed Cost curve for a typical firm. On the x-axis, the output of the firm is shown and on y-axis the average fixed cost incurred by the firm is shown. As it can be seen in the graph the curve of the Average Fixed Cost is a rectangular hyperbola. The area of rectangle OFCq gives the total fixed cost incurred by the firm.

At output of q on the horizontal axis, the corresponding Average Fixed Cost is F on the vertical axis. As the output increases, the Average fixed cost decreases and as the output decreases, the average fixed cost increases.

The formula to calculate the Total Fixed Cost is

Total Fixed Cost = Average Fixed Cost * Quantity i.e., TFC = AFC * q i.e., TFC = OF * Oq

Short Run Marginal Cost (SMC) Curve

The additional cost incurred by a firm to produce one more or extra unit of output is known as the Marginal Cost. According to the Law of Diminishing Marginal Product also known as Law of Diminishing Marginal Returns also known as Law of Variable Proportions, the marginal product (additional units produced) of a firm increase in the initial phase as the employment of factors of production is increased up to a certain point and after that the marginal product starts falling i.e., decreases for a firm.

So it means initially as the marginal product for a firm is high, the factors of production or resources required to produce every extra unit keeps on decreasing and after a certain point as the marginal product starts decreasing, the factors of production or resources required to product every extra unit starts increasing. Thus as requirement of marginal factors is lesser initially, the marginal cost reduces in the initial phase and as the marginal product starts falling, the requirement of factors to produce further extra unit increases, which results in increase in the marginal cost in later stage. In short till the factor proportions are favorable for the firm, the SMC falls, but once the factor proportions turn unfavorable, the SMC starts rising again thus confirming the Law of Variable Proportions. 

Thus, for given factor prices, the Short Run Marginal Cost (SMC), in the initial phase falls up to a certain point and then after that starts rising in the later stage. Hence the shape of Short Run Marginal Cost curve becomes U-Shaped.

The above graph shows the Short Run Marginal Cost curve for a typical firm. On the x-axis, output is shown and the Short Run Marginal Cost is shown on the y-axis. At zero output, the short run marginal cost is undefined. In the initial phase, as the output increases, the SMC falls and after a certain point when the factor proportions turn unfavorable, the SMC starts rising again.

Conclusion 

In this session, which was part 2 of the Shapes of Short Run Cost Curves, we discussed in detail regarding the Average Fixed Cost Curve and Short Run Marginal Cost Curve.