Relationship between the four cost curves in economics

Cost curve - Wikipedia

relationship between the four cost curves in economics

Relationship between Marginal Cost and Average Total Cost. -->. · Whenever Three Important Properties of Cost Curves are. -->. · Marginal. Curves can be drawn to represent costs. The marginal cost (MC) and the average cost (AC) are shown in the following diagram (). OX and OY are two axes. The fourth column shows the variable costs at each level of output. The relationship between the quantity of output being produced and the cost of . patterns of these curves, and the relationships and economic intuition behind them, will not.

Thus marginal cost initially falls, reaches a minimum value and then increases. When the marginal cost curve is above an average cost curve the average curve is rising. When the marginal costs curve is below an average curve the average curve is falling.

This relation holds regardless of whether the marginal curve is rising or falling. Stated otherwise, LRMC is the minimum increase in total cost associated with an increase of one unit of output when all inputs are variable. The long-run marginal cost curve tends to be flatter than its short-run counterpart due to increased input flexibility as to cost minimization. The long-run marginal cost curve intersects the long-run average cost curve at the minimum point of the latter.

Long-run marginal cost equals short run marginal-cost at the least-long-run-average-cost level of production. Graphing cost curves together[ edit ] Cost curves in perfect competition compared to marginal revenue Cost curves can be combined to provide information about firms. In this diagram for example, firms are assumed to be in a perfectly competitive market. In a perfectly competitive market the price that firms are faced with would be the price at which the marginal cost curve cuts the average cost curve.

Cost curves and production functions[ edit ] Assuming that factor prices are constant, the production function determines all cost functions. In this case, with perfect competition in the output market the long-run market equilibrium will involve all firms operating at the minimum point of their long-run average cost curves i. If, however, the firm is not a perfect competitor in the input markets, then the above conclusions are modified.

For example, if there are increasing returns to scale in some range of output levels, but the firm is so big in one or more input markets that increasing its purchases of an input drives up the input's per-unit cost, then the firm could have diseconomies of scale in that range of output levels. Conversely, if the firm is able to get bulk discounts of an input, then it could have economies of scale in some range of output levels even if it has decreasing returns in production in that output range.

If MC equals average total cost, then average total cost is at its minimum value. If MC equals average variable cost, then average variable cost is at its minimum value. Relationship between short run and long run cost curves[ edit ] Basic: But if demand changes it may be necessary to increase or decrease his output and he may consider it desirable to alter his scale of production.

Suppose at a particular time, a producer is under cost curve U2 and produces OQ0. He finds it necessary to produce OQ1. If he continues under the old scale his average cost will be Q1T.

Suppose he alters his scale so that his new cost curve is U3. The average cost of producing OQ1 is now Q1A.

relationship between the four cost curves in economics

Q1A is less than Q1T. So the new scale is preferable to the old and will be adopted. In the long run the average cost has changed from Q0R to Q1A.

Relationship between the long-run cost curve and the short-run cost curves: The long-run cost curve is a curve which shows how costs change when the scale of production is changed. This curve is obtained by drawing a line which touches the series of possible short-run cost curves.

The long-run cost curve is the locus of equilibrium point on the short-run cost curves. At the equilibrium points, a movement along the short-run cost curve and a movement along the long-run cost curve must involve the same change of cost. That is, the short-run and the long-run marginal costs must be equal.

This condition is satisfied only if the long-run average cost curve is tangential to the short- run average cost curves. The general opinion is that the long-run average cost curve is U-shaped, like the short-run average cost curve, but is flatter. This means three things: These propositions can be proved as follows: Initially the average cost decreases because certain economies of scale are available the economies of large scale production; economical use of the indivisible factors of production, etc.

When this stage comes the average cost begins to rise. In either case the rate of decrease or increase of costs is slower than file rates in the short run because fixed costs play a more important part in the short run. In the long run the fixed equipment can be altered. The equipment can be adjusted to the output.

In the short run such adjustment is not possible and, therefore, costs vary considerably with variation of output. Chamberlin observes that long-run average cost curve slopes downwards initially, primarily for two reasons: These two explanations overlap substantially.

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Economies and diseconomies arise not only from the proportions of the factors but also from the scale of operations. Shape of the LAC: Economies and Diseconomies of Scale: The shape of LAC depends on economies and diseconomies of scale. Economies of large-scale production or economies of scale means the advantages of being big and as the firm becomes bigger the average costs per unit of production fall. There are two types of economies of scale internal economies of scale and external economies of scale: Internal economies of scale: These economies arise from within the firm itself as a result of its own decision to become big.

As a result of becoming bigger the firm which experiences internal economies of scale enjoys a situation where average costs per unit of production are falling as output is rising. Therefore, the firm is becoming efficient. There are six main categories of internal economies — technical economies, financial economies, marketing economies, managerial economies, risk-bearing economies and welfare economies.

These arise due to internal efficiency and are enjoyed by a particular firm and not by others belonging to an industry. This involves such advantages as: Small firms employing on a few staff have less scope for division of labour. Moreover, the firm has the large output to fully occupy the machine over a long period of time and, therefore, it can be operated efficiently.

Indeed, some machines are indivisible in that they are only efficient if they are large in size, e. This is because they can offer more security for the loan than could a small firm and the risk of default is also less. They sometimes get these loans at lower rates of interest owing to confidence of the bank in their ability to repay.

Again investors are more likely to have confidence in buying these securities in a large company like the Tata Chemicals than in a small company like the Usha Martin Black or India Linoleums. Indeed the firm may produce so many related products that the brand name helps to advertise all of these different products. The large firms can afford to buy in bulk and they usually purchase raw materials in bulk and succeed in paying lower prices and enjoying special privileges e.

For instance, the large firm can afford to employ specialist sellers and buyers which will give great advantages. Moreover, packing and distribution costs are likely to be lower per unit of output as are transport, clerical and administration costs. It is usually cheaper per unit of output to package and distribute 1, units than units.

Specialist buyers and sellers can be employed. Businesses are faced with many risks, e. Large firms are better able to bear such a risk of decline in demand for a particular product because they will probably have diversified their output. They will produce a wide variety of different goods and can face the situation where demand for a particular product declines.

Risk-reduction is achieved through product diversification.

relationship between the four cost curves in economics

The large firm is also better able to sell products in different regions of India and even to export to other countries. Thus, again, they are able to spread their risks.

Therefore, if demand for the good declines then the small firm is likely to lose money considerably any go out of business. Large firms can afford, more than small firms, to spend money on providing good working conditions, canteens, social and leisure facilities for employees.

This makes workers happy and, therefore, more productive.

Economics: Marginal Cost and Average Cost curves

External economies of scale: These are the economies which apply to the industry as a whole and each particular firm can enjoy these economies as the industry expands. These external economies are especially evident where the industry has concentrated in a particular area, e. Since external economies of scale are often associated with industries concentrated in particular areas they are sometimes referred to as the economies of concentration.

External economies include the following advantages: Regional specialisation of labour: Labour in a particular area may become skilled at a specific occupation.

A firm in the area should have less of a problem in finding supplies of labour with the skills required. Such skills are handed down from generation to generation and the expectation is that the child will follow the parent into a particular trade.

For instance, in the West Midlands U. The type of education offered reinforces the industry which dominates the region. For instance, coal mining is especially important in Dhanbad and this is reflected in the type of educational facilities provided, e.

Specialised banking, marketing, insurance services will have grown up in the area to deal with the particular requirements of the industry. Development of ancillary firms: Ancillary firms provide components and parts for other firms. Such ancillary or subsidiary firms will exist and cater for the needs of the industry of the region. For instance, in and around Calcutta there are many firms producing components for the engineering industry. A good system of road, rail, air and sea links will be important to all firms in the area and they all share the advantages of the adequate provision of these links.

For instance, Mumbai has an airport, and is very well served by motorways, sea and rail links. The firms in the region may co-operate and take advantage of research centres in the area.

Also, firms may come together and form trade associations or chambers of commerce to represent the interests of the industry to the government and community as a whole. Diseconomies of scale will set in at some stage in title growth of the firm and result in rising per unit costs.

The Shape of a Firm’s Cost Curves in Long Run and Short Run

These are more difficult to identify but tend to be more managerial in nature. Problems of communication arise, as both lateral and vertical communications become difficult. It becomes difficult not only to ensure that instructions are received, but also that they are carried out correctly.