AmosWEB is Economics: Encyclonomic WEB*pedia 1

U-SHAPED COST CURVES:

The family of short-run cost curves consisting of average total
cost, average variable cost, and marginal cost, all of which
have U-shapes. Each is U-shaped because it begins with
relatively high but falling cost for small quantities of output,
reaches a minimum value, then has rising cost at large
quantities of output. Although the average fixed cost curve is
not U-shaped, it is occasionally included with the other three
just for sake of completeness.

The U-shapes of the average total cost, average variable cost, and
marginal cost curves are directly or indirectly the result of increasing
marginal returns for small quantities of output (production Stage I)
followed by decreasing marginal returns for larger quantities of output
(production Stage II). The decreasing marginal returns in Stage II result
from the law of diminishing marginal returns.

The U-shaped cost curves form the foundation for the analysis of
short-run, profit-maximizing production by a firm. These three curves can
provide all of the information needed about the cost side of a firm's
operation.

Bring on the Curves

The diagram to the right displays U-Shaped Cost Curves

the three U-shaped cost curves--
average total cost curve (ATC),
average variable cost curve (AVC),
and marginal cost curve (MC)--for
the production of Wacky Willy
Stuffed Amigos (those cute and
cuddly snakes, armadillos, and
turtles).

All three curves presented in this

diagram are U-shaped. In
particular, the production of
Wacky Willy Stuffed Amigos, like
other goods, is guided by
increasing marginal returns for
relatively small output quantities, then decreasing marginal returns for
larger quantities.

Consider a few reference points:

The marginal cost curve reaches its minimum value at 4 Stuffed

Amigos.

The average variable cost curve reaches its minimum at 6 Stuffed

Amigos.

The average total cost curve reaches its minimum at 6.5 Stuffed
Amigos.

The marginal cost curve for Stuffed Amigos production is the only one of
these three curves that is DIRECTLY affected by the law of diminishing
marginal returns. Up to a production of 4 Stuffed Amigos, increasing
marginal returns is in effect. From the 5th Stuffed Amigo on, decreasing
marginal returns (and the law of diminishing marginal returns) takes over.
The U-shaped pattern for the marginal cost curve that results from
increasing and decreasing marginal returns is then indirectly responsible
for creating the U-shape of the average variable cost and average total
cost curves.

The Average-Marginal Relation

The average total cost, average variable cost, and marginal cost curves
depict the basic mathematical relation that exists between any average
and the corresponding marginal.

Average Variable Cost: First, note the relation between the average
variable cost curve and the marginal cost curve. The marginal cost
curve intersects the average variable cost curve at its minimum
value. Moreover, when average variable cost is declining (the
average variable cost curve is negatively sloped), marginal cost is
less than average variable cost. And when average variable cost is
rising (the average variable cost curve is positively sloped),
marginal cost is greater than average variable cost.

Average Total Cost: Second, the average-marginal relation is also

seen with the average total cost curve. The marginal cost curve
http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd... 10/09/10 11:20 PM
intersects the average total cost curve at its minimum value, as
well. When average total cost is declining (the average total cost
curve is negatively sloped), marginal cost is less than average total