Cost Curves

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Cost Curves

Because so much of economics is taught using graphical analysis, it's very important to think about what the various costs of production look like in graphical form. Let's examine the graphs for the different measures of cost.

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Total Cost

Total cost is graphed with output quantity on the horizontal axis and dollars of total cost on the vertical axis. There are a few features to note about the total cost curve:

  • The total cost curve is upward sloping (i.e. increasing in quantity). This simply reflects the fact that it costs more in total to produce more output.
  • The total cost curve is generally bowed upwards. This isn't necessarily always the case- the total cost curve could be linear in quantity, for example- but is fairly typical for a firm for reasons that will be explained later.
  • The intercept on the vertical axis represents the firm's fixed total fixed cost since this is the cost of production even when output quantity is zero.
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Total Fixed Cost and Total Variable Cost

As stated earlier, total cost can be broken down into total fixed cost and total variable cost. The graph of total fixed cost is simply a horizontal line since total fixed cost is constant and not dependent on output quantity. Variable cost, on the other hand, is an increasing function of quantity and has a similar shape to the total cost curve, which is a result of the fact that total fixed cost and total variable cost have to add to total cost. The graph for total variable cost starts at the origin because the variable cost of producing zero units of output, by definition, is zero.

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Average Total Cost Can Be Derived from Total Cost

Since average total cost is equal to total cost divided by quantity, the average total cost can be derived from the total cost curve. Specifically, the average total cost for a given quantity is given by the slope of the line between the origin and the point on the total cost curve that corresponds to that quantity. This is simply because the slope of a line is equal to the change in the y-axis variable divided by the change in the x-axis variable, which in this case is, in fact, equal to total cost divided by quantity.

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Marginal Cost Can be Derived from Total Cost

Since, as stated earlier, marginal cost is the derivative of total cost, marginal cost at a given quantity is given by the slope of the line tangent to the total cost curve at that quantity.

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Average Fixed Cost

When graphing average costs, units of quantity are on the horizontal axis and dollars per unit are on the vertical axis. As shown above, the average fixed cost has a downward-sloping hyperbolic shape, since average fixed cost is just a constant number divided by the variable on the horizontal axis. Intuitively, an average fixed cost is downward sloping because, as quantity increases, fixed cost gets spread out over more units.

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Marginal Cost

For most firms, marginal cost is upward sloping after a certain point. It's worth acknowledging, however, that it's entirely possible for marginal cost to initially be decreasing before it starts increasing in quantity.

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Marginal Cost for a Natural Monopoly

Some firms, referred to as natural monopolies, enjoy such strong cost advantages to being big (economies of scale, in economic terms) that their marginal cost never starts sloping upwards. In these cases, marginal cost looks like the graph on the right (though marginal cost doesn't technically have to be constant) rather than the one on the left. It's worth keeping in mind, however, that few firms are truly natural monopolies.