Production and Costs Total Costs Shifts in the Cost Curves Page 1 of 2

In this lesson, we’ll look at the logic of the cost curves. What causes them to shift? You’ll remember that the cost curves have a very specific technical relationship. The marginal cost curve is upward sloping to represent the diminishing marginal product of labor. The average variable cost and average total cost curves are U-shaped, and each of those curves intersects the marginal cost curve at its minimum point. Also, remember that the vertical distance between the average total cost and the average variable cost curve represents average fixed cost at every point. Now the question: what causes each of these curves to shift?

Remember, a curve shifts when you change a variable that was held constant in drawing the curve originally. And what did we hold constant when we drew these cost curves? We held constant input prices and technology. That is, each of these cost curves is a relationship between the cost of production and the quantity of production, holding constant wages, the price of capital, and technology. Let’s consider now how changing each of these inputs would affect the picture.

First, we’ll consider a change in the price of labor. What happens if wages rise? Well, wages affect the marginal cost, the average variable cost, and the average total cost. If wages go up, we will see that each of these cost curves will have to rise to reflect new higher costs from higher wages. In fact, all of the cost curves will shift up together. That is, an increase in wages results in an upward shift in all the cost curves. It’s as if the whole structure has just been moved up to represent higher wages. The average variable cost curve will still be U-shaped. The average total cost curve: still U- shaped. Both curves still intersecting the marginal cost curve at their minimum points, and the marginal cost curve still upward sloping. The distance between the new average total cost curve and the new average variable cost curve at every point is still equal to average fixed costs. When you change the price of the variable input you have to shift all of the curves together. What if you change only the price of the fixed input?

Let’s consider, now, the case of capital. If the price of capital goes up, the average variable cost and the marginal cost don’t change because they don’t depend on the price of capital. The average total cost, however, includes fixed costs, and it must adjust to reflect the new price of capital. With a higher price of capital, the average total cost will shift upwards. Now, be careful whenever you’re drawing this shift to preserve two important features of the average total cost curve. First, it must intersect the marginal cost curve at its minimum point in its U-shape. Also, the average total cost curve and the average variable cost curve have a defined relationship. That is, the gap between them always reflects average fixed cost, and average fixed cost is headed toward zero as output increases. So, this gap has to get smaller and smaller and smaller as output increases. Here’s the new average total cost curve to reflect the higher price of capital. When the price of the fixed input alone rises, you shift only the average total cost curve.

We’ve considered the effect of changing input prices. Now let’s look at the effect of changing technology. Suppose that technology improves; that is, we have higher productivity in our production process. Higher productivity means that it takes fewer inputs to produce any given quantity of output, and that means that the cost of production will be lower for any given level of output. The cost curves in this case are going to generally shift downwards, that is, it will be less expensive to produce any given quantity of output than before.

Production and Costs Total Costs Shifts in the Cost Curves Page 2 of 2

Now, we can’t predict exactly how the cost curves will shift. That depends on the specific changes in technology. Are they in favor of making labor more productive, capital more productive, or some combination? But one thing you can be sure of, in the new configuration of cost curves the average total cost and average variable cost will continue to intersect marginal cost at their minimal points. Also, you can be sure that the relationship between average total and average variable will also be equal to average fixed costs.

In short, then, changes in technology shift the whole set of cost curves, sometimes in ways that aren’t completely predictable. However, the relationship among the three curves is always mathematically set.