Suppose labor is a variable input and capital is a fixed input, and consider a firm's short-run average, average variable, and marginal cost curves.
(i) What geometric relationships hold among these three curves?
(ii) How would these curves be affected by an increase in the wage rate paid to labor?
(iii) How would these three curves be affected by an increase in the rental rate paid to capital?
(i) All three curves are U-shaped. The average cost curve lies above the average variable cost curve, and the marginal cost curve crosses each one at its minimum point.
(ii) Average cost depends on both fixed and variable costs, while average variable cost and marginal cost depend solely on variable cost. All three curves would shift up when the wage rate rises, because wages are a variable cost.
(iii) Fixed costs will rise when the rental rate paid to capital rises. Fixed costs are one component of total cost, so the average cost curve will shift up. However, variable costs have not changed, so there is no shift in the average variable cost and marginal cost curves.
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