Page 188 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-9: Theory of Cost and Revenue

The production is 0 at point O but FC is 10. So the total cost is also 10. The difference between total Notes
and variable cost is equal to fixed cost. So there is equal difference between TC and VC curve. So both
the curves means TC and VC curve are parallel to each other.

Significance of Difference between the Fixed and Variable Costs

There is the significance of difference between the fixed and variable costs in short run.
Production decision during Depression or decision regarding Shut Down: The demand and the price
get low in short run due to crisis. The firm needs to decide whether to open its production or close. If firm
closes production even then it needs to bear the rent of building, the interest in fixed capital etc. So the
firm gets loss even it shut down the production in short run. Thus if in crisis time, the product’s price is as
low as to equal to variable cost, the firm will resume their production. It would bear the loss of fixed cost.
Firm will produce until it gets variable costs. But if the firm does not get variable cost, it will shut down its
production.

9.5 Average Cost

The average cost is the cost of per unit of product. Average cost is total cost divided by output. It has
three parts—(i) Average Fixed Cost (ii) Average Variable Cost (iii) Average Total Cost or Average Cost .

(i) Average Fixed Cost
Average fixed cost is the fixed cost per unit. Total fixed cost is divided by the quantity of output
average fixed cost that is called the quotient. Means,
FC
___
AFC =

Q
(Here AFC = average fixed cost, FC = fixed cost, Q = quantity of output).
Since fixed cost remain constant, therefore, produce higher fixed cost per unit is lower.
From Table 4 and Fig. 9.5 we can explain average fixed cost.

Table 4: Average Fixed Cost

Output (1) Fixed Cost in (2) Average Fixed Cost (3) = (2 ÷ 1)
1 10 10.0
2 10 5.0
3 10 3.3
4 10 2.5
5 10 2.0
6 10 1.7
7 10 1.4
8 10 1.2
From Table 4 it is clear that when one unit is produced the average fixed cost is ` 10. Opposite to
it when 5 units are produced then the average fixed cost decreases to ` 2. The average fixed cost of
production decreases with increase in production.
Figure 9.5 AFC is the average fixed cost line. The line Average Fixed Cost Curve is a
is sloping downward to the right. From the nature of Rectangular Hyperbola.
average fixed cost falling downward it is clear that The reason behind this is the area drawn beneath
any where this curve will touch OX axis. But it is not a rectangular hyperbola is equal. And all areas
possible because the point where AFC curve will represent a fixed cost which is fixed.
touch OX axis in that place AFC should be zero. But

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