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Not long ago, the Canadian edition of a famous textbook on principles of economics had a diagram depicting a U-shaped average fixed cost curve - Essay Example

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This occasioned great mirth around the campfires of some economists in the Great White North and did much to shorten a long hard…
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Not long ago, the Canadian edition of a famous textbook on principles of economics had a diagram depicting a U-shaped average fixed cost curve
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Question Not long ago, the Canadian edition of a famous textbook on principles of economics had a diagram depicting a U-shaped average fixed cost curve. This occasioned great mirth around the campfires of some economists in the Great White North and did much to shorten a long hard winter. Explain what is wrong with drawing a U-shaped average fixed cost curve.
Answer
Cost minimizing firms’ total cost (TC) curves can be given as;
TC1 =wL1+rK1⃓ (Q= Q1)
TC2=WL2+rK2 ⃓ (Q= Q2)
where, TC1 provides an isocost line (Besanko and Ronald 2005).
Above TC1 is the minimum cost of producing a given amount of output (Q1) by using different combinations of inputs which are labor (L1) and capital (K1). Along the curve, firm’s output level stays constant. When the firms increase level of output its total cost increase while shifting TC1 to TC2. In the long run firms can mobilize all the inputs used in production process.
Firm’s average cost (AC) is the ratio of total cost to level of outputs and AC curve is given by;
AC (Q) = TC (Q)/Q
Thus U-shaped AC and MC curves can be obtained as figure 1 below (AmosWEB).
Figure 1: Long Run Total, Average and Marginal Cost Curves
TC


AC(Q)=TC(Q)/Q
In the short run firms face two types of costs as fixed cost (FC) and variable cost (VC). Thus TC of firm in short run is given as;
TC1 =VC1+ FC ⃓ Q=Q1
TC2 =VC2+ FC ⃓ Q=Q2
Firm’s fixed cost derives from the recourses which it cannot be mobilized. Cost of fixed resources is not varied upon varying output levels. Thus stays constant in above two cost functions. Average fixed cost is the ratio of firms’ fixed cost and level of output which can be given as;
AFC= FC/Q
where AFC is a constant. Therefore firms’ average fixed cost continuously decreases with increasing output level. As depicted in figure 2 AFC is not a U shaped curve (Riley and Eton 2012).
Figure 2: Short Run AFC of Cost Minimizing Firms.

In conclusion cost minimizing firms’ AC curve can be illustrated using U-shaped curve. Firms’ FC is a constant value in the short run and hence AFC curve continuously decreases with increasing output level.
References
Besanko, David, and Ronald Braeutigam.2005.Cost Curves. In Microeconomics. 2th ed. Edited by Judith R.Joseph. New Jersey
Riley, Geoff, and Eton College. 2012."Markets & Market Systems." tutor2u. www.tutor2u.net/economics/revision-notes/a2-micro-supply-shortrun-costs.html.
AmosWEB. 2012.”Economics with a touch of Whimsy” http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=U-shaped+cost+curves. Read More
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