Economics with a Touch of Whimsy - Essay Example

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, the firm’s output level stays constant. When the firms increase the level of output its total cost increase while shifting TC1 to TC2. In the long run, firms can mobilize all the inputs used in the production process.

Firm’s average cost (AC) is the ratio of the total cost to the level of outputs and the 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

     AC(Q)=TC(Q)/Q

  In the short run, firms face two types of costs a fixed cost (FC) and variable cost (VC). Thus TC of the firm in the short-run is given as;

TC1 =VC1+ FC ⃓ Q=Q1

TC2 =VC2+ FC ⃓ Q=Q2

Therefore firms’ average fixed cost continuously decreases with the increasing output levels. 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 curves can be illustrated using a U-shaped curve. Firms’ FC is a constant value in the short run and hence AFC curve continuously decreases with the increasing output level.