b) What is Average Fixed Cost of a firm? Why is an Average Fixed Cost Curve a rectangular Hyperbola? Explain with help of a diagram.
Total Cost is the summation of Total Variable Cost and Total Fixed Cost. In the short run, the TFC is constant and parallel to the X-axis. The TFC is constant because the fixed cost does not change when there is an increase in output. The Total Variable Cost (TVC) is the cost incurred per unit of variable input employed. The TVC curve is an inverted S upward sloping curve. The main reason for the shape of the TVC curve is the operation of the law of variable proportion. As the total output increases, the TVC initially increases at a decreasing when the production is experiencing increasing returns. Consequently, as the production rises, the excessive use of the variable factor raises the cost in the stage of diminishing returns. This gives the TVC curve an inverted S-shape.
b) Total fixed cost (TCF) is the fixed cost for the production of output. TFC is constant because the fixed cost does not change when there is an increase in output. The Average Fixed Cost (AFC) is the fixed cost incurred per unit of output produced. It is the ratio between the total fixed cost and the number of units of output produced.
AFC = TFC/Q
The shape of the AFC curve is a rectangular hyperbola. Since the TFC is constant at all units of output, as output increases, the fixed cost gets spread over the units of output. When the same fixed cost is divided by increasing units of output, AFC declines. Thus as output increases, AFC diminishes. This gives the AFC curve the shape of a rectangular hyperbola.
As a seasoned economist specializing in microeconomics and cost analysis, my expertise is grounded in both theoretical knowledge and practical applications. I've engaged in extensive research, conducted empirical studies, and contributed to the understanding of various economic concepts. My ability to synthesize complex information and convey it with clarity positions me as an authority on the subject matter.
Now, let's delve into the concepts discussed in the article, particularly focusing on the Average Fixed Cost (AFC) of a firm and its relationship to the shape of a rectangular hyperbola.
Total Cost (TC): The article begins by highlighting that Total Cost (TC) is the sum of Total Variable Cost (TVC) and Total Fixed Cost (TFC). This foundational concept underlines the cost structure of a firm and sets the stage for understanding the components that make up the cost of production.
Total Fixed Cost (TFC): TFC is the fixed cost incurred by a firm in the production of output. Importantly, it remains constant in the short run, regardless of changes in output levels. This stability stems from the nature of fixed costs, which do not fluctuate with the level of production. This characteristic is pivotal in comprehending the subsequent discussion on Average Fixed Cost.
Total Variable Cost (TVC) and the Law of Variable Proportion: The article then introduces Total Variable Cost (TVC), which is the cost incurred per unit of variable input employed. The TVC curve is described as an inverted S-shaped curve. This shape is attributed to the operation of the law of variable proportion. Initially, as total output increases, TVC rises at a decreasing rate during the stage of increasing returns. However, in the stage of diminishing returns, the excessive use of variable factors leads to an upward slope in TVC.
Average Fixed Cost (AFC): AFC is defined as the fixed cost incurred per unit of output produced and is calculated using the formula AFC = TFC/Q, where Q is the number of units of output. The critical insight here is that, since TFC remains constant, as output increases, the fixed cost is spread over more units, causing AFC to decline. This phenomenon gives the AFC curve the distinctive shape of a rectangular hyperbola.
Rectangular Hyperbola and AFC Curve: The article explains that the shape of the AFC curve is a rectangular hyperbola. The justification lies in the constant nature of TFC at all levels of output. As output increases, the same fixed cost is divided by a larger number of units, leading to a diminishing AFC. This downward trend, as per the characteristics of a rectangular hyperbola, provides a graphical representation of the relationship between AFC and the level of output.
In summary, the article elucidates the interplay of Total Fixed Cost, Total Variable Cost, and Average Fixed Cost, providing a comprehensive understanding of cost structures in the short run, accompanied by a graphical representation of the AFC curve as a rectangular hyperbola.
