Cost CurvesUsing rental cost for the cost of the services of fixed capital, average cost is total cost-fixed cost plus variable cost-per unit of output. Average variable cost is variable cost per unit of output.

The short-run average cost and average variable cost curves are usually drawn with the parabolic shapes. These illustrate the law of diminishing marginal productivity: as more and more variable inputs are combined with a given amount of fixed inputs, a point is reached after which output per unit of variable inputs begins to decline.

In the short run, the capitals stock the fixed. It does not vary with output or with the number of workers hired. When output is low, the firm will hire only a few workers. There will not be enough workers to handle the available capital stock efficiently; that is, workers will not be terrible productive. Output per worker will be relatively low, so that the variable cost per unit of output will be high.

Output can be increased, in the short run, only by hiring additional workers. As output rises and more employees are added, the work force approaches the size that can most effectively manage the available capital stock. Workers become more productive, and variable cost per unit of output declines. There is therefore an intermediate range of output over which the average variable cost curve falls toward its lowest level.

As output increases even more, additional workers are hired. But a point is reached at with labor start to “crowd” the available capital stock. Congestion develops, labor productivity begins to decline again, and average variable cost begins to rise. When the output per unit is variable input falls, the variable cost per unit of output rises. The change in output per worker as the size of the work force changes explains the shape of the average variable cost curve