1. Introduction
In the short run, at least one factor of production (e.g., capital or land) is fixed, while other factors (e.g., labour, raw materials) can be varied. This leads to different cost behaviours as output changes.
2. Types of Costs in the Short Run
- Total Fixed Cost (TFC)
- Remains constant at all output levels.
- Includes costs like rent, salaries of permanent staff, and machinery.
- Total Variable Cost (TVC)
- Varies with the level of output.
- Includes raw materials, wages of temporary workers, and electricity for production.
- Total Cost (TC)
- The sum of fixed and variable costs.
- Formula: TC = TFC + TVC
- Average Fixed Cost (AFC)
- Fixed cost per unit of output.
- Formula: AFC = TFC / Output
- AFC decreases as output increases (spreading effect).
- Average Variable Cost (AVC)
- Variable cost per unit of output.
- Formula: AVC = TVC / Output
- AVC follows a U-shape due to increasing and then diminishing returns.
- Average Total Cost (ATC)
- Total cost per unit of output.
- Formula: ATC = TC / Output or ATC = AFC + AVC
- ATC is U-shaped due to economies and diseconomies of scale.
- Marginal Cost (MC)
- Additional cost incurred by producing one more unit of output.
- Formula: MC = ΔTC / ΔOutput
- MC initially decreases due to increasing returns but then rises due to diminishing returns.
3. Relationship Between Costs and Output
| Output (Units) | TFC (₹) | TVC (₹) | TC (₹) | AFC (₹) | AVC (₹) | ATC (₹) | MC (₹) |
|---|---|---|---|---|---|---|---|
| 0 | 100 | 0 | 100 | – | – | – | – |
| 1 | 100 | 50 | 150 | 100 | 50 | 150 | 50 |
| 2 | 100 | 80 | 180 | 50 | 40 | 90 | 30 |
| 3 | 100 | 100 | 200 | 33.3 | 33.3 | 66.6 | 20 |
| 4 | 100 | 120 | 220 | 25 | 30 | 55 | 20 |
| 5 | 100 | 150 | 250 | 20 | 30 | 50 | 30 |
| 6 | 100 | 190 | 290 | 16.6 | 31.6 | 48.3 | 40 |
| 7 | 100 | 250 | 350 | 14.2 | 35.7 | 50 | 60 |
Observations from the Table:
- AFC continuously decreases as output increases.
- AVC first decreases and then increases, forming a U-shape.
- ATC follows a U-shape due to AFC reduction initially and AVC increase later.
- MC declines initially, reaches a minimum, and then rises, reflecting the law of diminishing returns.
4. Graphical Representation of Short-Run Cost Curves
The diagram represents the relationship between different cost curves in the short run as output increases. The key curves shown are:
- Average Fixed Cost (AFC) – Downward Sloping
- Average Variable Cost (AVC) – U-Shaped
- Average Total Cost (ATC) – U-Shaped
- Marginal Cost (MC) – U-Shaped
1. Understanding the Cost Curves
(i) Average Fixed Cost (AFC)
- AFC continuously declines as output increases because total fixed cost (TFC) remains constant and is spread over more units.
- Formula: AFC = TFC / Output
- In the graph, AFC slopes downward and never rises.
(ii) Average Variable Cost (AVC)
- AVC initially decreases due to increasing returns to variable factors (labour specialization).
- After a certain level of output, AVC rises due to diminishing returns (higher cost per unit of additional output).
- This results in a U-shaped curve.
- Formula: AVC = TVC / Output
(iii) Average Total Cost (ATC)
- ATC is the sum of AFC and AVC:
ATC = AFC + AVC - It is also U-shaped but remains above AVC because it includes AFC.
- The gap between ATC and AVC is AFC, which decreases as output increases.
(iv) Marginal Cost (MC)
- MC represents the additional cost of producing one more unit of output.
- Initially decreases, reaches a minimum, and then rises due to the law of diminishing returns.
- The MC curve intersects AVC and ATC at their lowest points, indicating the most efficient production level.
2. Key Relationships Between the Curves
- MC cuts AVC and ATC at their minimum points – This is a rule in cost analysis, indicating where costs are lowest.
- ATC is always above AVC because ATC includes AFC, which is always positive.
- AFC declines continuously, pulling ATC downward at first, but eventually, rising AVC pulls ATC upward.
- The U-shape of AVC, ATC, and MC is due to the law of diminishing returns, which states that after a certain point, adding more variable inputs leads to higher per-unit costs.
5. Conclusion
- In the short run, fixed costs do not change, while variable costs vary with output.
- The cost-output relationship is mainly influenced by the law of diminishing returns, causing AVC, ATC, and MC to first decrease and then rise.
- Businesses must consider these cost behaviours when making short-run production and pricing decisions.