Answer to Question #131580 in Microeconomics for sahar

Question

I. Illustrate the link between the cost-minimization problem and total cost curve. What would happen to the total cost curve if the firm increases level of output?
II. Explain why the average variable cost (AVC) and average total cost (ATC) curves are U-shaped (decreasing, reaches minimum and then increasing)?

Answer 1

Solution:

I.).  The long-run total cost curve plots the minimized total cost for each level of output, having the input prices fixed. That is, for any given set of input prices, the long-run total cost curve depicts the total cost corresponding to the solution to the long-run cost minimization problem for every output level.

The total cost curve will remain the same while the total cost will increase by shifting to the right if the firm increases the level of output.

2.). The reason why the average variable cost (AVC) and average total cost (ATC) curves are U-shaped is because of the law of diminishing marginal return that indicates that after some level of optimal capacity is accomplished, the addition of an extra factor of production will result to smaller increases in output. Typically, AVC and ATC curves are U-shaped since fixed costs are all incurred before the start of any production, and marginal costs are usually increasing as a result of diminishing marginal productivity.

During low levels of production, marginal costs are below average costs; hence average costs are decreasing as quantity increases. As such, an increasing marginal cost curve transverses a U-shaped average cost curve at the latter’s minimum; afterward, the AVC and ATC curves begin to slope upwards. When there is further increase in production beyond its minimum, the marginal cost goes beyond average costs; hence average costs are increasing as quantity increases, and as such, AVC and ATC curves begin to slope upwards.

Therefore, AVC and ATC decrease due to increasing marginal returns as a result of variable factors, reach the minimum points when marginal return begins, then finally increase due to the same diminishing marginal returns.