Short-run average cost curve

Definition

The short-run average cost curve represents the average cost per unit of output when at least one input is fixed, typically capital. It reflects how costs change as production increases or decreases in the short run, showing the relationship between total cost and output level. This curve is U-shaped due to initially decreasing costs from increased efficiency and then rising costs as diminishing returns set in.

5 Must Know Facts For Your Next Test

1. The short-run average cost curve typically has a U-shape due to economies of scale at lower output levels followed by diseconomies of scale at higher levels.
2. In the short run, firms cannot adjust all inputs, leading to fixed costs that impact average costs significantly.
3. As production increases, average costs may initially decline because of improved efficiency and then rise due to the effects of diminishing marginal returns.
4. The minimum point on the short-run average cost curve indicates the most efficient scale of production for that period.
5. The shape and position of the short-run average cost curve can shift based on changes in technology or input prices.

Review Questions

• How does the concept of diminishing returns relate to the shape of the short-run average cost curve?
  • Diminishing returns occur when adding more of a variable input to a fixed input results in smaller increases in output. This principle directly affects the short-run average cost curve's U-shape. Initially, as production increases, average costs decrease due to improved efficiency. However, beyond a certain point, adding more labor or materials leads to less efficient production processes, causing average costs to rise.
• Analyze how fixed and variable costs influence the behavior of the short-run average cost curve.
  • Fixed costs remain constant regardless of output levels, impacting the average cost per unit at all production levels. Variable costs change with output; as production increases, these costs increase. The interplay between fixed and variable costs determines the overall shape of the short-run average cost curve. In the early stages of production, average costs decline due to fixed costs being spread over a larger output. However, as production continues to grow, variable costs begin to dominate, causing average costs to rise.
• Evaluate how shifts in technology or input prices can affect the short-run average cost curve for a firm.
  • Shifts in technology or input prices can lead to changes in the short-run average cost curve's position and shape. For example, if a firm adopts new technology that increases productivity, this can lower both fixed and variable costs, shifting the curve downward. Conversely, an increase in input prices can raise variable costs, shifting the curve upward. These shifts impact decision-making for firms regarding pricing and output levels, ultimately influencing their competitiveness in the market.

Related terms

Fixed Costs:

Costs that do not change with the level of output, such as rent and salaries, which remain constant in the short run.

Variable Costs:

Costs that change directly with the level of production, like raw materials and labor, which increase as more output is produced.

Marginal Cost:

The additional cost incurred from producing one more unit of output, which is crucial for understanding production decisions.