Q.
What are the common curves that are plotted in the study of costs? What are the two axis? In your own language, explain why in real life, marginal cost may initially reduce and gradually rise in an increasing output.
A.
The Y-axis is Total Cost or Cost, the X-axis is Quantity produced or Quantity.
Generally, there are 3 Blue lines and 1 Red line.
Blue lines are Fixed Cost, Variable Cost and Total Cost. And, as they are all divided by the quantity produced (meaning to share out to individual unit of product), they are then called Average Fixed Cost (AFC), Average Variable Cost (AVC) and Average Total Cost (ATC). Thus, the curve shows the various costs per unit average when the firm is producing that quantity of output (Q).
Red line is different from the above cost lines as it is marginal cost - the additional cost to produce the next unit of product. As it is the next additional cost, there is no average. If the firm is running out of space or tools for its additional workers, the workers become unproductive. However, wages are required in employment, therefore marginal cost begins to increase.
On the other hand, during the start of the business, fixed cost is high, and space and resources like machinery and tools are in abundance, additional worker might in fact lower the marginal cost as more quantity is produced with effective specialization and team work. For example, when one worker has to pack the bags, and move the bags to another station with a forklift he may be able to produce 10 units of output per hour. However, if there is an additional worker who can operate the forklift, the synergy of them might possibly yield 40 bags per hour. This divided by two is 20 bags per hour - doubling productivity per head. Hence, if the wage costs X per worker, the additional cost of new worker X is compensated by the increase in productivity of 30. So, the marginal cost per unit in fact has decreased!
This phenomenon can be seen in the second graph below.
As more and more workers are employed to increase production, the space and equipment - in the above scenario, factory space, the tools used to pack the bags and the forklift are limited in number, hence the efficiency drops. Thus, higher cost per unit is produced as wages start to kick in. This translate to increasing marginal cost and therefore the marginal cost line begins to rise and becomes 'v' shaped.
Own Account with reference to Mankiw, N. Gregory. 2012. Principles of Economics, South-Western Cengage Learning. Page 267-272.
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