It can be explained as under: i Law of Increasing Returns or the Law of Diminishing Costs: When a firm produces under the law of increasing returns, it means that as it employs more and more factors of production, its output increases at an increasing rate. Long-Run Marginal Cost : Long-run marginal cost shows the change in total cost due to the production of one more unit of commodity. Costs in Long Run Period : Long-run is a period in which there is sufficient time to alter the equipment and the scale or organization with a view to produce different quantities of output. Likewise, it has diseconomies of scale is operating in an upward sloping region of the long-run average cost curve if and only if it has decreasing returns to scale, and has neither economies nor diseconomies of scale if it has constant returns to scale. Long run total cost curve represents the least cost of different quantities of output. This is shown in the following table: Matches Played Total Runs Average Runs Marginal Runs 3 180 60 — 4 230 57. The behavioral assumption is that the firm will choose that combination of inputs that will produce the desired quantity at the lowest possible cost.
This shows that they fall steeply at the initial levels of output, reach their minima, and shoot up thereafter as fast as they had dived down. Finally, if the additional unit of output produced costs same as the average cost incurred on the previous units, the overall average cost does not change and attains its minimum value. Average Fixed Costs : This is the cost of indirect factors, that is, the cost of the physical and personal organization of the firm. This means, when marginal score is less than average score, average score must be falling. When marginal cost is equal to average cost, it is the minimum point of the latter. . Further, when the marginal cost exceeds the average cost, each extra unit of output produced adds more to the total cost than the average cost incurred on the previous units, resulting in rise in the overall average cost of production.
When a firm selects a proper scale of plant in order to produce a given quantity of output then at this level of output short run and long run marginal cost curves are equal. Therefore, the average cost curve as well as marginal cost curve remains parallel to horizontal axis. The Average Variable Cost curve, Average Cost curve and the Marginal Cost curve start from a height, reach the minimum points, then rise sharply and continuously. The firm also has some small sized machinery which set a limit to expansion. Conversely, if the firm is able to get bulk discounts of an input, then it could have economies of scale in some range of output levels even if it has decreasing returns in production in that output range. It can be shown with the help of figure 12. A given level of output can be had from a special plant to which it is appropriated.
Short-run costs are those which can be varied with almost no time lag. A monopoly will produce where its average cost curve meets the market demand curve under average cost pricing, referred to as the average cost pricing equilibrium. The fixed costs include costs on account of: 1 The salaries and other expenses of administrative staff; 2 Salaries of staff involved directly in production but paid on a fixed-term basis; 3 The depreciation of machinery; 4 Expenses on account of the maintenance of the factory-buildings; 5 Expenses connected with the maintenance of land on which the plant is installed and operated. In Figure 16 long-run average cost has been shown. But according to modern economists, in real life cost curves are L-shaped. Therefore, it is tangent to any given point, on short run total cost. It can be shown with the help of a figure 19.
Marginal cost is the addition to total cost, when one more unit of output is produced. The fall in marginal cost is much more than the average cost, so the marginal cost remains below the average cost. A typical average cost curve will have a U-shape, because fixed costs are all incurred before any production takes place and marginal costs are typically increasing, because of. An example is generation, which has no fuel expense, limited maintenance expenses and a high up-front fixed cost ignoring irregular maintenance costs or useful lifespan. The relationship between the two can be better illustrated through following schedule and diagram. Long-Run Average Cost Curve : Long-run average cost is the long run total cost divided by the level of output. Average cost curves may therefore only be shown over a limited scale of production for a given technology.
It falls up to point E and then rises upward. If, such a plant is put to operation, goods will be produced at the lowest average cost. With in the output market the long-run market equilibrium will involve all firms operating at the minimum point of their long-run average cost curves i. For example, if there are increasing returns to scale in some range of output levels, but the firm is so big in one or more input markets that increasing its purchases of an input drives up the input's per-unit cost, then the firm could have diseconomies of scale in that range of output levels. It is important to note that as long as the marginal cost is less than average cost, each additional unit of output will add less to total cost in comparison to the average per unit cost incurred on the previous units. This is shown by the boundary line N. For example, a nuclear plant would be extremely inefficient very high average cost for production in small quantities; similarly, its maximum output for any given time period may essentially be fixed, and production above that level may be technically impossible, dangerous or extremely costly.
} It is also equal to the sum of average variable costs total divided by Q and average fixed costs total divided by Q. The Average Fixed Cost curve approaches zero asymptotically. This given level of output represents reserved capacity output. Specifically, the fixed costs involved with a natural monopoly imply that average cost is greater than marginal cost for small quantities of production. The curves touch their respective lowest points before shooting up again. Average cost will be neither decreasing nor increasing when marginal cost at a given quantity is equal to average cost at that quantity. An can be plotted with cost on the vertical axis and quantity on the horizontal axis.
Assume that a cricketer say, Sachin Tendulkar has scored 180 runs in 3 matches. Modern Theory of Cost Curves : Modern theories of costs have been provided by economists like Stigler, Andrews, Sargent, Florence and Friedman etc. The Marginal Cost curve always passes through the minimum points of the Average Variable Cost and Average Cost curves, though the Average Variable Cost curve attains the minimum point prior to that of the Average Cost curve. On the other hand, when marginal cost lies above the average cost curve, the average cost rises pulled upwards by the marginal cost. The firm can also expand output by purchasing some additional small-sized machinery.
Industries with fixed marginal costs, such as electrical transmission networks, may meet the conditions for a , because once capacity is built, the marginal cost to the incumbent of serving an additional customer is always lower than the average cost for a potential competitor. This distinction becomes irrelevant when calculating marginal cost using very small changes in quantity produced. The answer is very simple. This flat stretch represents the built-in reserve capacity of the plant. When average cost is neither rising nor falling at a minimum or maximum , marginal cost equals average cost. Average Variable Cost : In modern economics, the average variable cost includes wages of labour employed, cost of raw- material, and running expenses of machinery.