Average cost (AC) is the total cost (TC) divided by quantity. AC= TC/Q
Average variable cost (AVC) is the total variable cost (VC) divided by quantity AVC = VC/Q
FC = Fixed costs – not changing with output
VC = Variable costs – which do change with output
TC Total costs = FC+VC
Short-run average costs
Short-run average cost curves tend to be U shaped because of the law of diminishing returns.
In the short run, capital is fixed; initially, marginal cost falls until diminishing returns set in. After this point, marginal cost starts to rise rapidly and so average costs start to rise as well. The reason for diminishing returns is that employing extra workers starts to lead to shortage of capital and
Diagram of short-run average cost with Marginal Cost
Long run average costs
In the long run, all factors of production are variable (capital and labour). Therefore, in the long-run, we don’t get diminishing returns. The slope of the long-run average cost can be very different and we can experience economies and diseconomies of scale.