How do average variable cost, average fixed cost, and marginal cost vary as prod

Question

How do average variable cost, average fixed cost, and marginal cost vary as production levels for a firm are increased?

Consider how short-term costs compare to long term costs. Answer the following questions and provide specific examples to support your answers:

1- are short term costs linked to just one input factor as a variable, with all other factors held constant as production increases?

2-Are long term costs linked to all inout factors changing over time? Why or Why not?

3-What does the term economics of scale mean? Explain in terms of increasing economies of scale and decresing economies of scale.

PLEAS GIVE EXAMPLES.

Explanation / Answer

When the production levels of a firm are incresed, the average fixed cost falls because fixed cost is the cost which does not change with the change in the level of output. And AFC falls as the output increases because the total fixed cost gets spread over larger number of output. For example : you take a land on rent for $500 for your packaging business. This $500 is the fixed cost, no matter what you pack, how many you pack, you have to pay the rent. Now if you start by packing 100 units a month, the AFC = 500/100 = $5. As the the level of output increases to 500 units, AFC =500/500 = 1. So AFC falls as output increases.

Variable cost is the cost which changes with the level of output. So as the output increases, variable cost also increases. AVC is nothing but VC/output. So as the output increases, AVC also increases. Continuing the previous example of packaging. As the output increases to 500 units, you need more cartoons to pack, more labour, etc. which incurs more cost. Thus, variable cost increases, anf hence average variable cost also increases.

Mariginaal cost is the cost of producing one additional unit of output. It is change in total cost/change in output. As the output increases, MC first falls and then starts rising, this is because of law of variable proportions.

1. This is true that in short run there is only one input-output relationship that is depicted by the production function and short run costs. This is illustrated by the law of variable proportion.

2. Yes, long term costs are linked to all input factors changing over time and especially the fixed factors because the variable factors were already changing. Continuing the example, now if the production level increases over time from 500 units to 1500 units, the space required would eventually increase, so to expand, the fixed factor land will over a period of time converts into a variable factor and probably more land would be taken on lease. When the production increases, all the inputs change.

3. Economies of scale means the reduction in the per unit cost as the volume of production increases. There are various reasons for this. First, as we already know that as the output increases, the AFC falls as it not spreads over larger number of output. Secondly, as the production level increases, we would bulk purchase the raw materials and may get heavy discounts. Finally, the cost may be reduced because of the increased volume which may justify acquiring specialized equipment and the efficiency of labour might increase. For example: a car manufacturing robot's efficiency is fully utilised when it produces 5 cars per day. Else you may need to spend the same amount if you are producing anything less than 5 cars a day. So, producing 5 cars, brings you economies of scale.

Increasing economies of scale implies when the average cost per unit reduces with the increasing level of output.

Say for example, you are a resturant owner, since you need a lot of vegetable, you may bulk buy it from a wholesale dealer. You might often come across deal like this one in real. If you puchase 1 kg of onins, it might cost you $20, while if you puchase, 20kgs in one go, it might cost you $350. You were benefitted by purchasing in bulk quantity.

Decreasing returns to scale implies when the average cost per unit rises, rather than falling, as the output increases. There could be several reasons for this. Firstly, the transportation cost might go up compensating the economies of scale and finally making the cost go up. Secondly, there could be administrative flaws, like manager not keeping an eye properly on the worker's efficiency, the worker might not be working properly, etc. Finally, the production of your good might require a raw material that might cost you more, like oil, the price of which fluctuates a lot.

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