PAC - Graphing the Cost Curves Lesson

APMicroeconomics_LessonTopBanner.png

Graphing the Cost Curves Lesson

The basic behavior of the production function and the cost measures is the same at any firm, for any market structure. Therefore, there are generic cost curves that can be drawn to represent costs at any given firm.  

Because there are two basic types of costs considered by the firm, total and average, there are two types of graphs that can be drawn.  

"Totals" Graph

This graph includes total variable cost, total fixed cost, and total cost. Quantity (Q) is placed on the x-axis and costs (dollar amounts $) are placed on the y-axis. The graph below shows the generic "totals" curves. Let's consider the relationship between these "totals."

Totals Graph

Totals Graph X-axis – Quantity Y-axis – Costs TC and TVC run parallel to each other, separated by the amount of TFC. TC = TVC+TFC, so TC – TVC = TFC TFC Horizontal at $ value of fixed cost. Because TVC is a cot that varies with production, when production = 0, TVC = 0. Assuming the existence of fixed costs, TC will always originate from the same points as TFC. At lower levels of production, TFC is the bulk of the firm’s cost. At higher levels of production, TVC makes up the greater percentage of TC.

Recall, TC = TVC + TFC. Therefore, the total cost curve will always be placed above the TVC and TFC curves. Because total fixed cost is fixed, or constant, it can be drawn as a horizontal curve fixed at the dollar amount of total fixed cost (assuming the existence of fixed cost, this will always be a dollar amount greater than $0). The total variable cost curve will always originate at the origin because TVC varies with production. That is, when a firm is producing 0 units of output, it will have $0 in variable cost. The total cost curve will originate at the same value on the y-axis as the TFC curve. That is because when output is at 0 units, the firm will still have fixed cost although it would have a $0 variable cost.  

Oftentimes, the "totals" graph will only display two of the three "totals" curves - TC and TFC or TC and TVC. The distance between the two curves displayed will be the value of the third cost measure.

Totals Curve Graph 1 X-axis – Quantity Y-axis – Costs 2 points are on the X-axis labeled Q1 and Q2. TFC is a horizontal line under which is labeled Fixed Cost at Q1 and Q2. Above TFC variable costs are labeled for Q1 and Q2. The TVC curve does not have to be shown. The TVC exists between TC and TFC at a given Q. Remember, TC = TVC+TFC, so TC – TVC = TFC

 

Totals Curve Graph 2 X-axis – Quantity Y-axis – Costs Four points are labeled on the X-axis – Q1, Q2, Q3, and Q4. The TVC curve does not have to be drawn. The TFC exists between TC and TVC curves. Remember, TC = TVC+TFC, so TC – TVC = TFC

What does a "totals" graph reveal?

A "totals" graph will only reveal information related to TC, TVC, and TFC. That is, only vertical distances can be read on this graph.

"Averages" Graph

This graph includes average total cost, average fixed cost, average variable cost, and marginal cost. Quantity (Q) is placed on the x-axis and costs (dollar amounts $) are placed on the y-axis. The graph below shows the generic "averages" curves. Let's consider the relationship between these "averages."

Averages Graph X-axis – Quantity Y-axis - $ Dollars MC must intersect ATC and AVC at their lowest points. ATC and AVC curves must be drawn getting closer together as production expands to reflect decreasing AFC. APP is maxed at the point at which MC and AVC meet. MPP is maxed at the bottom of the MC curve. (lowest $, lowest quantity)

Short Run Costs of Production

View the following video to learn more about the relationship between a firm's short-run costs of production. To make the video full screen, click the double arrows at the bottom right corner of the object.

What will an "averages" graph reveal?

An "averages graph" obviously can be read to determine average cost values. This would mean reading vertical distances at a particular quantity. However, "averages graphs" can also be read to determine "total" values (TC, TVC, and TFC). When reading an "averages" graph to determine "'total" values, you will find rectangular areas. Remember, to find the area of a rectangle using this equation -  A = L x W.

Why do rectangular areas reveal values for the "total" cost measures?

The graph is explicitly displaying averages. Averages are found by dividing a "total" by a particular quantity. So, if you have an average value and would like to get back to the "total" value, you would multiply the average by the quantity.

Reading Averages Graph

Reading Averages Graph X-axis – Quantity Y-axis - $ Dollars MC must intersect ATC and AVC at their lowest points. ATC and AVC curves must be drawn getting closer together as production expands to reflect decreasing AFC. APP is maxed at the point at which MC and AVC meet. MPP is maxed at the bottom of the MC curve. (lowest $, lowest quantity)

Do we really need these diagrams?

The video below highlights the finer points of reading "totals" and "averages" graphs. To make the video full screen, click the double arrows at the bottom right corner of the object.

What Happens When Costs Change?

Sometimes, costs at firms will change. These changes can be the result of changes in resource costs, taxes, subsidies, and a variety of other factors. When costs at the firm change, the cost curves will either shift up (showing an increase in costs) or down (showing a decrease in cost). It is appropriate to view these shifts as "up" or "down" because costs are measured on the vertical axis.  

Two types of changes can occur in costs. A "per unit" change can occur. If this is the case, then MC, AVC, and ATC are all impacted. All three of these curves are impacted because they each are impacted by per unit changes in production. However, a "lump sum" change can also occur in costs. If this is the case, then only ATC is impacted (because it would equate to a change in fixed cost and ATC includes fixed costs).

Changes in Costs Graphs 1 and 2

Changes in Costs Graph 1 Lump Sum Tax Increases only ATC X-axis – Quantity Y-axis - $ Dollars Curves for MC, AVC, and two curves for ATC (one yellow, one purple) are shown. An arrow pointing upward is between the ATC curves. Changes in Costs Graph 2 X-axis – Quantity Y-axis - $ Dollars Per unit, tax increases ATC and MC. There are 4 curves on the graph – MC, MC1, ATC, and ATC1. MC1 and ATC1 are above the curves for MC and ATC. There are arrows pointing upward between the curves showing the shift upward between MC and MC1 and ATC and ATC1. *AVC has been omitted to make graph easier to read. If it appeared on the graph, it would also shift up.

APMicroeconomics_LessonBottomBanner.png

IMAGES CREATED BY GAVS