EconomicsISC Class 12 · Cost and Revenue

Cost Concepts and Short-Run Cost Curves: Fixed, Variable, Average and Marginal Cost

Q: What is the difference between fixed and variable cost?

Fixed cost does not change with output in the short run; variable cost changes with output.

Q: Why is the AC curve U-shaped?

Because of increasing and then diminishing returns to the variable factor, and because the falling AFC is eventually outweighed by the rising AVC.

Q: What is opportunity cost?

The value of the next best alternative foregone.

Q: What is the difference between accounting cost and economic cost?

Accounting cost counts explicit payments only; economic cost adds the implicit cost of the owner's resources.

Updated 17 October 2026 · Fact-checked

Total cost (TC) is total fixed cost (TFC) plus total variable cost (TVC). Average cost (AC) = TC/Q = AFC + AVC, and marginal cost (MC) is the extra cost of one more unit: MC = change in TC (equal to the change in TVC). AFC always falls, AVC and AC are U-shaped, and MC cuts both AVC and AC at their minimum points.

Understand Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships

1. Basic cost concepts (ISC list).

Money cost: the cost expressed in money terms (payments for inputs).
Real cost: the efforts and sacrifices (of labour, saving, waiting) involved in production, not measured in money.
Explicit cost: payments actually made to outsiders for inputs (wages, raw materials, rent paid, interest paid).
Implicit cost: the imputed value of the owner's own resources used in the business (own building, own capital, own time).
Economic cost = explicit + implicit cost (including normal profit). Accounting cost = explicit cost only.
Private cost: the cost borne by the producer; social cost: private cost plus the costs imposed on society (such as pollution).
Opportunity cost (meaning only): the value of the next best alternative given up. Accounting cost counts only recorded payments, whereas opportunity (economic) cost also counts the foregone alternative.

2. Short-run cost concepts. In the short run some inputs are fixed.

Total fixed cost (TFC): does not change with output (rent, insurance); it exists even at zero output. The TFC curve is a horizontal line. This is why fixed cost is a short-run phenomenon: in the long run every cost can be varied.
Total variable cost (TVC): changes with output; zero at zero output.
Total cost: TC = TFC + TVC.
Average fixed cost: AFC = TFC/Q; falls continuously as output rises (a rectangular hyperbola) because the same fixed cost is spread over more units.
Average variable cost: AVC = TVC/Q; first falls, then rises (U shape).
Average cost: AC = TC/Q = AFC + AVC; U shaped.
Marginal cost: MC = TCn - TCn-1 = TVCn - TVCn-1 (fixed cost does not change with output).

3. Shapes and reasons. The U shape of AVC, AC and MC arises from the law of variable proportions: increasing returns to the variable factor at first lower the cost per unit; after the optimum, diminishing returns raise it. MC reaches its minimum first, then AVC, then AC, because AFC keeps falling after AVC has begun to rise.

4. Relationships among the curves.

When MC < AC, AC falls; when MC > AC, AC rises; the MC curve cuts the AC curve at its minimum point. The same applies to AVC.
AC lies above AVC by the amount of AFC; the gap narrows as output rises but never vanishes.
TC is the sum of MC: TVC = sum of MC (TC = TFC + sum of MC).

5. Long-run versus short-run cost curves (concepts only). In the long run all inputs vary, so there are no fixed costs. The long-run average cost curve is also U-shaped because of returns to scale (economies then diseconomies); it is related to the short-run curves as a boundary that touches them, but its derivation is not required in ISC.

Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships: key facts

Total cost: TC = TFC + TVC
Average costs: AFC = TFC/Q; AVC = TVC/Q; AC = TC/Q = AFC + AVC
Marginal cost: MCn = TCn - TCn-1 = TVCn - TVCn-1
Economic cost: Economic cost = explicit cost + implicit cost
Relationship: MC < AC: AC falls; MC > AC: AC rises; MC = AC at minimum AC

How to answer Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships questions

Cost schedule problems are filled column by column from whichever cost is given.

1Identify TFC (cost at zero output, or the constant part of TC).
2Find TVC = TC - TFC for each output level.
3Compute AFC, AVC and AC by dividing by output; check AC = AFC + AVC.
4Compute MC as the difference between consecutive TC (or TVC) values.
5Compare MC with AC to explain why AC rises or falls.
6Present the answer in a table and add the relationship in one line.

Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Explicit and implicit costs of a small bakery

Suppose Sunita runs a bakery in her own shop (which could be rented out for Rs 12,000 a month) and works full time herself (she could earn Rs 20,000 a month elsewhere). She pays Rs 30,000 for workers' wages, Rs 50,000 for flour and other materials and Rs 8,000 for electricity. Her monthly sales are Rs 1,10,000.

Find explicit cost, implicit cost, economic cost, accounting profit and economic profit.

Try it first, then show the solutionSolution

Explicit cost = 30,000 + 50,000 + 8,000 = Rs 88,000.
Implicit cost = 12,000 + 20,000 = Rs 32,000.
Economic cost = 88,000 + 32,000 = Rs 1,20,000.
Accounting profit = 1,10,000 - 88,000 = Rs 22,000; economic profit = 1,10,000 - 1,20,000 = - Rs 10,000.

Answer: Accounting profit is Rs 22,000, but after counting the foregone rent and salary the economic result is a loss of Rs 10,000.

Memory hook: What I give up is also a cost.

Tricks to remember Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships

Short memory aids. Say each one aloud once, then use it on a question the same day.

MC is the marginal student
A new student with a score below the class average pulls the average down; above it pushes the average up. MC and AC behave the same way.
Use it when: Relationship questions.
AC = AFC + AVC
AC is the sum of two curves: the falling AFC and the U-shaped AVC. That is why AC bottoms out later than AVC.
Use it when: Why minimum AC comes after minimum AVC.
Fixed means short run
In the long run nothing is fixed.
Use it when: Examiner-flagged reasoning question.

Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships: solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Where MC cuts AC · 1 mark · MCQBoard level

The marginal cost curve cuts the average cost curve at:
(a) the maximum point of AC
(b) the minimum point of AC
(c) any point on AC
(d) the point where AC is horizontal

Try it first, then show the solutionSolution

MC pulls AC down while below it and pushes it up when above it; it crosses at the lowest point.

Answer: (b) the minimum point of AC

Example 2: Filling a cost schedule · 3 marks · Short answerBoard level

TFC is Rs 60. TVC for 1 to 4 units is Rs 30, 50, 66 and 84. Calculate TC, MC and AC for each unit. (3 marks)

Try it first, then show the solutionSolution

TC = 60 + TVC = 90, 110, 126, 144.
MC = 30; 110 - 90 = 20; 126 - 110 = 16; 144 - 126 = 18.
AC = 90/1 = 90; 110/2 = 55; 126/3 = 42; 144/4 = 36.

Answer: TC = 90, 110, 126, 144; MC = 30, 20, 16, 18; AC = 90, 55, 42, 36.

Example 3: Complete schedule and relationships · 4 marks · Long answerHarder board level

TFC is Rs 60 and TVC for 1 to 6 units is Rs 20, 36, 48, 64, 90 and 126. Prepare a schedule of AFC, AVC, AC and MC. Verify that AC = AFC + AVC and say at which unit AVC is lowest and what MC is then. (4 marks)

Try it first, then show the solutionSolution

TC: 80, 96, 108, 124, 150, 186.
AFC = 60/Q: 60, 30, 20, 15, 12, 10.
AVC = TVC/Q: 20, 18, 16, 16, 18, 21.
AC = TC/Q: 80, 48, 36, 31, 30, 31. Check AFC + AVC at the 5th unit: 12 + 18 = 30; at the 6th: 10 + 21 = 31.
MC: 20, 16, 12, 16, 26, 36 (also equal to the change in TC).
AVC is lowest (16) at the 3rd and 4th units; at the 4th unit MC = 16 = AVC, so MC meets AVC at its minimum.

Answer: AFC: 60, 30, 20, 15, 12, 10; AVC: 20, 18, 16, 16, 18, 21; AC: 80, 48, 36, 31, 30, 31; MC: 20, 16, 12, 16, 26, 36. AVC is minimum (Rs 16) where MC = AVC.

Example 4: MC and AC · 4 marks · Short answerHarder board level

In the schedule above the AC of 5 units is Rs 30. (a) If the MC of the 6th unit is Rs 36, find the AC of 6 units and say whether AC rises or falls. (b) If instead the MC of the 6th unit were Rs 24, find the AC. Explain the rule. (4 marks)

Try it first, then show the solutionSolution

TC of 5 units = 5 x 30 = Rs 150.
(a) TC6 = 150 + 36 = 186; AC6 = 186/6 = Rs 31, above Rs 30: AC rises because MC (36) > AC (30).
(b) TC6 = 150 + 24 = 174; AC6 = 174/6 = Rs 29, below Rs 30: AC falls because MC (24) < AC (30).
Rule: MC above AC raises AC, MC below AC lowers AC, so MC cuts AC at its minimum.

Answer: AC rises to Rs 31 in (a) and falls to Rs 29 in (b), showing that the position of MC relative to AC decides the direction of AC.

Example 5: Why AC bottoms out after AVC · 4 marks · Short answerHOTS / competency

Using the previous schedule, explain with figures why the minimum of AC (at the 5th unit) occurs at a higher output than the minimum of AVC (3rd and 4th units), and why fixed cost is called a short-run concept. (4 marks)

Try it first, then show the solutionSolution

From the 4th to the 5th unit, AVC rises from 16 to 18 (up by 2) while AFC falls from 15 to 12 (down by 3), so AC still falls: 31 to 30.
From the 5th to the 6th unit, AVC rises by 3 (18 to 21) but AFC falls by only 2 (12 to 10), so AC rises: 30 to 31.
AC therefore turns up only after AVC has already begun to rise, because the falling AFC offsets the rise for a while.
Fixed cost is a short-run concept because plant, building and similar inputs cannot be changed quickly; over the long run all inputs can be varied, so no cost remains fixed.

Answer: AC is lowest (Rs 30) at the 5th unit, after AVC's minimum, because the falling AFC keeps pulling AC down for one more unit. Fixed cost exists only in the short run since all costs vary in the long run.

Where students lose marks in Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships

The slips examiners see most often, and what to write instead.

Mistake: Computing MC from AC
Subtracting AC values.
Wrong working
MC of the 3rd unit = 42 - 55 = -13.
Right working
MC = change in TC = 126 - 110 = Rs 16.
Do this: MC uses TC (or TVC), never AC.
Usually costs: 2 marks.
Mistake: Treating MC as passing through the minimum of TC
Mixing totals with averages.
Wrong working
MC cuts AC at the minimum of TC.
Right working
MC cuts AC at the minimum of AC.
Do this: Name the curves exactly.
Usually costs: 1 mark.
Mistake: Adding fixed cost into MC
Forgetting that fixed cost does not change.
Wrong working
MC = TFC + change in TVC.
Right working
MC = change in TVC = change in TC.
Do this: Fixed cost drops out of MC.
Usually costs: 1-2 marks.
Mistake: Mixing accounting and economic cost
Ignoring implicit cost.
Wrong working
Economic cost of the bakery = Rs 88,000.
Right working
Economic cost = 88,000 + 32,000 = Rs 1,20,000.
Do this: Add the imputed value of the owner's inputs.
Usually costs: 2 marks.

Exam tips

Draw one diagram with AFC, AVC, AC and MC: AFC falling, MC cutting AVC and AC at their minimum points, AC above AVC.
Give the reason for the U shape in terms of the law of variable proportions (the examiner report lists this as a hard area).
In schedules, check AC = AFC + AVC and MC = change in TC to avoid slips.
Learn the list of ISC cost terms: private, economic, social, money, real, explicit and implicit.
Opportunity cost is meaning only; do not derive long-run curves.

Practice questions on Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
The average fixed cost curve:
(a) is U-shaped
(b) rises throughout
(c) falls throughout
(d) is a horizontal line
Hint
TFC is fixed while output rises.
Answer
(c) falls throughout
Q2 · 3 marks · Short answerBoard level
TFC is Rs 120 and TVC for 1 to 4 units is Rs 40, 70, 90 and 120. Calculate TC, MC and AC for each unit. (3 marks)
Hint
TC = TFC + TVC.
Answer
TC = 160, 190, 210, 240; MC = 40, 30, 20, 30; AC = 160, 95, 70, 60.
Q3 · 4 marks · Short answerHarder board level
A shopkeeper pays wages of Rs 30,000, material cost of Rs 50,000 and electricity of Rs 8,000 a month, and sells goods worth Rs 1,10,000. He uses his own shop (rental value Rs 12,000) and could earn Rs 20,000 elsewhere. Find explicit cost, implicit cost, accounting profit and economic profit. (4 marks)
Hint
Implicit cost counts the owner's own inputs.
Answer
Explicit cost = 30,000 + 50,000 + 8,000 = Rs 88,000. Implicit cost = 12,000 + 20,000 = Rs 32,000. Accounting profit = 1,10,000 - 88,000 = Rs 22,000. Economic cost = 1,20,000, so economic profit = 1,10,000 - 1,20,000 = - Rs 10,000 (a loss).
Q4 · 4 marks · Short answerHarder board level
The average cost of 1 to 5 units is Rs 50, 40, 34, 32 and 34. Find the total cost and the marginal cost of each unit. State where AC is minimum and compare MC with AC at that point. (4 marks)
Hint
TC = AC x Q.
Answer
TC = 50, 80, 102, 128, 170. MC = 50, 30, 22, 26, 42. AC is minimum (Rs 32) at the 4th unit. MC of the 4th unit (Rs 26) is below AC (Rs 32) so AC is still falling there, while MC of the 5th unit (Rs 42) exceeds AC (Rs 34) so AC rises; MC cuts AC from below at its minimum.
Q5 · 3 marks · Short answerHOTS / competency
Explain, using the idea of AFC and AVC, why the AC curve is U shaped, and why MC always cuts AC at AC's minimum. (3 marks)
Hint
AC = AFC + AVC.
Answer
AC = AFC + AVC. At first both fall (AFC falls as output rises and AVC falls under increasing returns), so AC falls. Later AVC rises under diminishing returns by more than AFC falls, so AC rises: a U shape. MC is the marginal addition; when it is below AC the new unit lowers the average and when it is above AC it raises the average, so the crossing point is where AC stops falling and starts rising: its minimum.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.TC formula?Show answer
TFC + TVC.
2.MC equals the change in which cost?Show answer
Total cost (equal to the change in total variable cost).
3.Which cost curve falls throughout?Show answer
AFC.
4.Explicit versus implicit cost?Show answer
Explicit is paid to outsiders; implicit is the imputed value of the owner's own resources.
5.Where does MC cut AVC?Show answer
At the minimum of AVC.

Cost Concepts and Short-Run Cost Curves: TC, AC, MC and Their Relationships: frequently asked questions

What is the difference between fixed and variable cost?

Fixed cost does not change with output in the short run; variable cost changes with output.

Why is the AC curve U-shaped?

Because of increasing and then diminishing returns to the variable factor, and because the falling AFC is eventually outweighed by the rising AVC.

What is opportunity cost?

The value of the next best alternative foregone.

What is the difference between accounting cost and economic cost?

Accounting cost counts explicit payments only; economic cost adds the implicit cost of the owner's resources.