CUET UG Economics: Microeconomics - Cost Concepts, Short Run vs Long Run Costs, Relationship Between AC and MC

Must-Know (15–20 detailed bullets)

• In the short run, at least one factor of production is fixed; in the long run, all factors are variable. Example: A factory cannot change its building size in the short run but can build a new one in the long run.

• Total Cost (TC) = Total Fixed Cost (TFC) + Total Variable Cost (TVC). For example, if TFC = ?500 and TVC = ?300, then TC = ?800.

• Fixed costs do not change with output; e.g., rent for a factory space remains ?10,000/month regardless of units produced.

• Variable costs change with output; e.g., raw material cost increases from ?2,000 to ?4,000 when production doubles.

• Average Cost (AC) = TC / Quantity. If TC = ?1,000 and output = 10 units, AC = ?100 per unit.

• Average Fixed Cost (AFC) = TFC / Q; it continuously falls as output increases. If TFC = ?600 and Q = 6, AFC = ?100; if Q = 10, AFC = ?60.

• Average Variable Cost (AVC) = TVC / Q. If TVC = ?400 for 8 units, AVC = ?50/unit.

• Marginal Cost (MC) = Change in TC / Change in Q. If TC increases from ?500 to ?560 when output rises from 4 to 5 units, MC = ?60.

• MC intersects AC at its minimum point. This occurs because when MC < AC, it pulls AC down; when MC > AC, it pulls AC up.

• The U-shape of the AC curve is due to the law of diminishing returns in the short run.

• The long-run average cost (LRAC) curve is the envelope of all short-run average cost (SRAC) curves, touching each at one point.

• LRAC is U-shaped due to economies and diseconomies of scale. Economies of scale reduce per-unit cost as firm size increases initially.

• In the long run, there are no fixed costs; all costs are variable. Thus, TFC = 0 in the long run.

• When MC < AC, AC is falling. For example, if AC = ?80 and MC = ?60, producing an additional unit reduces average cost.

• When MC = AC, AC is at its minimum. This is the point of tangency between MC and AC curves.

• Diminishing marginal returns occur in the short run due to fixed factors, causing MC to rise after a certain output level.

• The vertical distance between AC and AVC curves represents AFC, which decreases as output increases.

• In the long run, firms can adjust plant size, so LRAC shows the lowest possible AC for each output level across different plant sizes.

• If a firm doubles inputs and output more than doubles, it experiences increasing returns to scale (economies of scale).

• Verify from NCERT: The exact shape of the LAC curve (whether it has a flat stretch) depends on the technology and is discussed in Class 12 NCERT.

Difficulty Level

Intermediate — Requires understanding of graphical relationships and cost behavior across time frames, but no advanced calculus or external data.

Common CUET Traps (3 bullets)

• Trap: Believing that fixed costs can be eliminated in the short run.
  Avoid: Fixed costs exist regardless of output in the short run; they cannot be changed immediately.

• Trap: Confusing MC with AC and assuming both always move together.
  Avoid: MC can rise while AC is still falling, as long as MC remains below AC.

• Trap: Assuming the long-run average cost curve has fixed inputs.
  Avoid: In the long run, all inputs are variable; no fixed factors exist.

Practice MCQs (5 questions)

Q1. Which cost remains constant as output increases in the short run?
A. Total Variable Cost
B. Marginal Cost
C. Total Fixed Cost
D. Average Cost

Answer: C
Explanation: TFC does not change with output in the short run.
Why others fail: TVC increases with output, making A incorrect.

Q2. When marginal cost is less than average cost, what happens to average cost?
A. AC remains constant
B. AC increases
C. AC decreases
D. AC becomes zero

Answer: C
Explanation: MC pulls down AC when it is below AC.
Why others fail: Students often confuse this with MC = AC, where AC is minimum.

Q3. At which point does the marginal cost curve intersect the average cost curve?
A. At the maximum of AC
B. At the minimum of AC
C. When AC is rising
D. When AC is falling

Answer: B
Explanation: MC cuts AC at its lowest point due to averaging effect.
Why others fail: Some assume intersection happens during rising phase only.

Q4. Which of the following best describes the long-run average cost curve?
A. It is based on fixed plant size
B. It is the sum of all fixed costs
C. It is an envelope of short-run AC curves
D. It always slopes downward

Answer: C
Explanation: LRAC touches each SRAC at one point, forming an envelope.
Why others fail: Option A describes short run, not long run.

Q5. Suppose total cost increases from ?1,200 to ?1,500 when output increases from 10 to 12 units. What is the marginal cost of the 12th unit?
A. ?100
B. ?125
C. ?150
D. ?300

Answer: C
Explanation: MC = ?TC / ?Q = (1500 – 1200)/(12 – 10) = 300/2 = ?150.
Why others fail: Option D gives ?TC only, ignoring division by ?Q.

Last?Minute Revision (15–20 one?liners)

• In short run, at least one input is fixed; in long run, all inputs are variable.
• TFC remains constant at all output levels in short run.
• TVC is zero when output is zero.
• TC = TFC + TVC — always.
• AFC = TFC/Q-continuously declines as Q rises.
• AVC = TVC/Q — U-shaped due to diminishing returns.
• AC = AFC + AVC — sum of average fixed and variable costs.
• MC = ?TC/?Q — measures cost of one additional unit.
• MC curve is U-shaped due to law of variable proportions.
• MC cuts AC at its minimum point — key graphical relationship.
• When MC < AC, AC falls; when MC > AC, AC rises.
• LRAC curve is tangential to all SRAC curves.
• LRAC shows minimum cost of producing each output in long run.
• No fixed costs exist in the long run — all costs variable.
• Economies of scale-falling LRAC; diseconomies-rising LRAC.
• Constant returns to scale-LRAC is flat over a range.
• Diminishing returns operate only in short run due to fixed factors.
• Verify from NCERT: The U-shape of AC and MC curves is due to returns to a factor (short run).
• Verify from NCERT: The shape of LRAC reflects returns to scale.
• MC affects AC but not necessarily in the same direction.