Cost
Fixed, variable, average, and marginal cost — and why short-run cost curves are U-shaped.
Definition
Cost of production refers to the total expenditure incurred by a firm on the factors of production and other inputs required to produce a given level of output.
Simple Explanation
Cost is the price a firm pays — in money and resources — to make what it sells.
Detailed Explanation
In the short run, total cost splits into Total Fixed Cost (TFC — unchanged by output, e.g. rent) and Total Variable Cost (TVC — changes directly with output, e.g. raw materials), so TC = TFC + TVC.
From TC we derive Average Fixed Cost (AFC = TFC/Q, which keeps falling as output rises since fixed cost is 'spread' over more units), Average Variable Cost (AVC), Average Cost (AC = AFC + AVC), and Marginal Cost (MC, the change in TC for one more unit). These short-run curves are U-shaped because of the Law of Variable Proportions.
MC cuts both AVC and AC at their minimum points — a direct mirror image of how MP and AP behave in production theory, because cost curves are essentially the inverse of product curves.
This inverse relationship is precise, not just a coincidence: when Marginal Product is rising, Marginal Cost must be falling (extra workers add more output for the same extra wage, so each extra unit costs less); when MP starts falling under diminishing returns, MC starts rising. The same logic links AP to AVC. This is why CBSE often expects you to connect a Cost answer back to the Law of Variable Proportions from the Production chapter.
In the long run, every cost becomes variable — a firm can change its factory size, machinery, and workforce, so there is no fixed cost to speak of. The Long-Run Average Cost (LRAC) curve is typically drawn as a flatter, shallower U formed by the lower envelope of many short-run average cost curves, each representing a different plant size; its shape traces out economies of scale (falling LRAC) and diseconomies of scale (rising LRAC) as a firm grows.
Real-life Examples
Bakery's fixed vs variable cost
A bakery's monthly rent is a fixed cost paid even at zero output; flour and sugar are variable costs that rise with every extra loaf baked.
Spreading overheads
As a factory produces more units, its fixed machinery cost gets spread over more units, pulling AFC steadily downward.
Step-by-step Graph
- 1
Plot AFC
Draw AFC as a curve continuously falling and approaching, but never touching, the X-axis — a rectangular hyperbola.
- 2
Plot AVC and AC
Draw AVC and AC as U-shaped curves, with AC lying above AVC by exactly the (falling) AFC at every output level.
- 3
Plot MC
Draw MC as a U-shaped curve that falls faster and rises faster than AVC and AC.
- 4
Mark intersections
MC cuts AVC at the minimum point of AVC, and cuts AC at the minimum point of AC — both from below.
Formulas
Total Cost
TC = TFC + TVC
Sum of fixed and variable costs at a given output level.
Average Cost
AC = TC / Q = AFC + AVC
Per-unit cost of production.
Marginal Cost
MCn = TCn − TCn−1
Extra cost of producing one more unit of output.
Tables
| Concept | Formula | Behaviour as output rises |
|---|---|---|
| AFC | TFC / Q | Continuously falls |
| AVC | TVC / Q | U-shaped |
| MC | ΔTC / ΔQ | U-shaped; cuts AVC and AC at their minimum points |
Common Mistakes
- Believing fixed cost is 'zero' in the short run — it is constant, not zero.
- Drawing MC cutting AC and AVC anywhere other than exactly at their minimum points.
- Confusing short-run cost (some inputs fixed) with long-run cost (all inputs variable, no fixed cost).
Exam Tips
- Always justify the U-shape of short-run cost curves using the Law of Variable Proportions — examiners reward this link.
- In numericals, build the full cost schedule (TFC, TVC, TC, AFC, AVC, AC, MC) before answering sub-parts.
- Remember AFC is never shown touching the X-axis in a correctly drawn diagram.
Summary
- Total Cost = Total Fixed Cost + Total Variable Cost in the short run.
- AFC continuously falls; AVC and AC are U-shaped.
- MC is U-shaped and intersects AVC and AC exactly at their minimum points.
- Cost curves mirror product curves because cost is the inverse of productivity.
- In the long run, all costs are variable — there is no fixed cost.
Practice MCQs
1. Average Fixed Cost (AFC) continuously falls as output rises because:
2. Marginal Cost cuts the Average Cost curve at:
3. In the short run, Total Cost equals:
4. Average Variable Cost (AVC) and Average Cost (AC) curves are both:
5. The vertical distance between the AC and AVC curves at any output level equals:
6. In the long run, a firm's costs are best described as:
7. If Marginal Cost is rising, Marginal Product of the variable factor must be: