In Economics, the average variable cost is the variable cost per unit. Average variable cost is determined by dividing the total variable cost by the output. The firms use the average variable cost to determine when to stop their production in the short term.
The average variable cost (AVC) curve is a graphical representation of the average cost of producing each unit of output, considering only variable costs. Variable costs are costs that change with the level of output, such as raw materials, direct labor, and energy.
The AVC curve is U-shaped for several reasons:
Marginal productivity of inputs: In the short run, as more units of variable input are added to a fixed amount of capital, the marginal productivity of the variable input initially increases and then decreases. This leads to a U-shaped AVC curve.
Law of diminishing returns: The law of diminishing returns states that as more and more of a variable input is added to a fixed input, the marginal product of the variable input eventually decreases. As a result, the AVC curve becomes U-shaped as the cost of producing additional units of output increases due to the diminishing returns of the variable input.
Spreading of fixed costs: In the short run, some costs, such as rent and property taxes, are considered fixed because they do not change with the level of output. As more units of output are produced, the fixed costs are spread over a larger number of units, which reduces the average fixed cost (AFC) and contributes to the U-shaped AVC curve.
Therefore, the AVC curve is U-shaped because of the interplay between the law of diminishing returns and the spreading of fixed costs over a larger number of units as production increases.
