Cost Curves
The short-run marginal cost (MC) curve will at first decline and then will go up at some point, and will intersect the average total cost and average variable cost curves at their minimum points.

The average variable cost (AVC) curve will go down (but will not be as steep as the marginal cost), and then go up. This will not go up as fast as the marginal cost curve.

The average fixed cost (AFC) curve will decline as additional units are produced, and continue to decline.

The average total cost (ATC) curve initially will decline as fixed costs are spread over a larger number of units, but will go up as marginal costs increase due to the law of diminishing returns.

The graph below illustrates the shapes of these curves.

Figure 3.8: Cost Curves

Diminishing Returns and Diminishing Marginal Product of Capital
T
he law of diminishing returns states that as one type of production input is added, with all other types of input remaining the same, at some point production will increase at a diminishing rate.

There may be levels of input where increasing inputs causes production to go up at an increasing rate. However, according to the law of diminishing returns, at some point production will go up at a decreasing rate.

The marginal product of capital is the increase in total output associated with an increase in capital, while holding the quantity of labor constant. Capital is also subject to the law of diminishing returns.

Economies of Scale
Economies of scale mean that goods can be produced at a lower cost per good, as the quantity produced increases. Large-scale factory operations can permit the most efficient specialization of machinery and labor. Average fixed costs will decline as costs such as advertising can be spread across more and more units.
Diseconomies of Scale
Diseconomies of scale occur when per unit costs go up as output is increased. A typical reason given is bureaucratic inefficiencies - more attention may be given to administrative rules as opposed to innovation. Worker motivation is also more difficult as the number of employees increases.

When economies of scale occur, the long-run average total cost (LRAC) curve will be declining; with diseconomies of scale, the LRAC curve will be rising.

Figure 3.9: Long Run Average Total Curve

Perfectly Competitive Markets

Related Articles
  1. Investing

    Trade Bond ETFs Using Yield Curves

    Different types of yield curves provide important insights for trading bond-based securities.
  2. Investing

    What Is Supply?

    Supply is the amount of goods a producer is willing to produce at a given price, and is one of the most basic concepts in economics.
  3. Investing

    A Flattening Yield Curve Is Good For The Economy and Stocks

    Wall Street is concerned because the yield curve is flattening, but that doesn't mean a recession is near.
  4. Investing

    Will an Inverted Yield Curve Happen Again?

    Explore the causes of inverted yield curves, their frequency, their accuracy in forecasting recessions and whether this type of event can happen again.
  5. Investing

    Understanding the Inverted Yield Curve

    An inverted yield curve occurs during the rare times when short-term interest rates are higher than long-term interest rates.
  6. Insights

    Is a Recession Coming? Watch the Yield Curve

    The yield curve can be an indicator of which way the economy is heading.
  7. Investing

    Interest Rates And Your Bond Investments

    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
  8. Investing

    Bond Yield Curve Holds Predictive Powers

    This measure can shed light on future economic activity, inflation levels and interest rates.
  9. Investing

    One Thing The Yield Curve Says About Stocks

    Contrary to media hype, a flattening yield curve does not mean a recession is coming soon.
Frequently Asked Questions
  1. What's considered to be a good debt-to-income (DTI) ratio?

    Your debt-to-income ratio helps lenders determine your credit worthiness. Find out how to calculate your score and how to ...
  2. What is the difference between a loan and a line of credit?

    Learn to differentiate between lines of credit and standard loans, and determine when you are likely to use each method of ...
  3. What does a Chief Financial Officer (CFO) do?

    A CFO is responsible for accurate reporting of a company's financial information, investing the company's money and identifying ...
  4. How did George Soros break the Bank of England?

    George Soros pocketed $1 billion by betting against the British pound, cementing his reputation as the premier currency speculator ...
Trading Center