Shape of Average Variable Cost (AVC) Curve and Shape of Short Run Average Cost (SAC) Curve
In previous two part of Shapes of the Short Run Cost Curves, we discussed in detail several concept of costs for a firm in the short run. The short run for a firm is a time period in which the firm has at least few factors of production or inputs in use which it cannot alter i.e., increases or decreases its employment in order to change the level of output or production. The factors of production which the firm cannot alter i.e., they remain fixed or constant are called Fixed Factors. The other factors which the firm can vary are called Variable Factors. Basis on this classification, there are several costs incurred by the firm in the short run and it becomes important for the firm to study the trends of these costs in order to realize its objective of maximum profitability.
These short run costs are Total Fixed Cost (TFC), Total Variable Cost (TVC), Total Cost (TC), Average Fixed Cost (AFC), Average Variable Cost (AVC), Short Run Marginal Cost (SMC) and Short Run Average Cost (SAC). We already have discussed these costs in detail in our previous sessions.
In the first part of the series of Shapes of Short Run Cost Curves, we studied the graphical representation i.e., shapes of curves of Total Fixed Cost (TFC), Total Variable Cost (TVC) and Total Cost (TC). In the second part we studied in detail Average Fixed Cost (AFC) Curve and Short Run Marginal Cost (SMC) Curve. In this session which is the 3rd part of Shapes of Short Run Cost Curve, we will study the Shape of Average Variable Cost (AVC) Curve and Short Run Average Cost (SAC) Curve.
Average Variable Cost (AVC) Curve
In the previous session we discussed regarding the Short Run Marginal Cost (SMC) Curve, where we saw that the SMC curve initially falls as the additional employment of factors required to increase output falls initially. Thus to produce each additional unit of output, firm requires less and less of additional input thus resulting in a fall in the short run marginal cost. After a certain point, there comes a level above which the requirement of factors for producing each additional unit of output starts increasing thus resulting in increase in short run marginal cost. Now this is turn affects the Average Variable Cost.
Initially when the output is zero and the first unit of output is produced, the Short Run Marginal Cost (SMC) and Average Variable Cost (AVC) are the same. Because the variable cost to produce the first unit will also be the additional cost to produce the first unit when output is zero. Hence both the Short Run Marginal Cost (SMC) Curve and Average Variable Cost (AVC) Curve start from the same point.
Now when the output starts further increasing, as explained above, the Short Run Marginal Cost (SMC) starts falling. The Average Variable Cost (AVC) is nothing but the average of the Marginal Costs or in other words the Total Variable Cost for any output level is the sum of all Marginal Cost incurred up to that level of output. Hence even the Average Variable Cost (AVC) falls following the Short Run Marginal Cost (SMC).
And after a certain point, the Short Run Marginal Cost (SMC) starts rising or increasing. But still the Average Variable Cost (AVC) continues to fall as long as the value of Short Run Marginal Cost (SMC) remains less than that of the Average Variable Cost (AVC). Then when the Short Run Marginal Cost (SMC) has risen sufficiently i.e., the value of Short Run Marginal Cost (SMC) has become greater than that of the Average Variable Cost (AVC), the Average Variable Cost (AVC) too starts rising again, thus following the Short Run Marginal Cost (SMC). Hence the Average Variable Cost (AVC) is U - Shaped.
The above graph shows the graphical representation of the Average Variable Cost (AVC) Curve. The output is shown on the x-axis and the Average Variable Cost (AVC) is shown on the y-axis. As can be seen in the AVC curve, the AVC initially falls with the Short Run Marginal Cost (SMC) and then as the value of SMC starts rising and becomes greater than the AVC, even the AVC start rising following the SMC. The area shown by rectangle OVBq, shows the total variable cost for output level of q.
One important thing to note here is that till the time the AVC is falling, the SMC should be lesser than the AVC, and when the AVC starts rising, the SMC should be greater than the AVC. This follows that, the SMC curve should cut the AVC curve from below, at the minimum point of AVC curve.
In the above graph, at q level of output, the Average Variable Cost (AVC) is OV. The Total Variable Cost for output level of q can be derived as
Total Variable Cost = Average Variable Cost * Quantity (q) i.e.,
TVC = OV * q i.e.,
TVC = area of rectangle OBVq
Short Run Average Cost (SAC) Curve
Short Run Average Cost (SAC) is the sum of Average Fixed Cost (AFC) and Average Variable Cost (AVC). In the initial phase, as the level of output increases, the AFC as well as AVC falls and thus even the Short Run Average Cost (SAC) falls. As explained earlier, after a certain level of production, the AVC starts rising but the AFC still keeps falling. At this point, the fall in AFC is greater than the rise in AVC, which keeps the Short Run Average Cost (SAC) still falling. But still moving further after a certain level of production, the rise in AVC becomes greater than the fall in AFC, and from this point onwards the Short Run Average Cost (SAC) starts rising. And hence, the shape of Short Run Average Cost (SAC) curve is U – Shaped.
It is important to note here that, the Short Run Average Cost (SAC) curve lies above the Average Variable Cost (AVC) curve with a vertical distance being equal to the Average Fixed Cost (AFC).
And as explained earlier, that even after AVC start rising, the SAC keeps falling up to a certain, hence the minimum point of SAC lies to the right of minimum point of AVC.
Another thing to note is, similar to the case of AVC and SMC, till the time the SAC is falling, the SMC is lesser than the SAC. From the point when the SAC starts rising, the SMC becomes greater than the SAC.
The minimum point of SAC curve is A with corresponding output level of q2. To the left of q2, SAC is falling and as the production increases beyond q2, the SAC starts rising to the right of q2. The SMC curve cuts the SAC at the minimum point of SAC curve at A. To the right of q2, SMC is greater than SAC.
Conclusion
In this session, which was the 3rd and last part of series of session explaining, Shape of Short Run Cost Curves, we discussed in detail the shape of Average Variable Cost (AVC) Curve and Short Run Average Cost (SAC) Curve. And finally we discussed, how all the costs namely AVC, SMC and SAC operate simultaneously.
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