What are the relationship between marginal cost and average total cost schedule?

Answer 1

Marginal cost is the cost incurred in producing an additional unit of a product. It is the cost per unit of a product as against the total cost. It is therefore the variable cost of producing one more unit of a product.

Average total cost is the total cost of production at an activity level. it is the total cost of divided by the total production.

Whiles marginal cost shows the cost incurred in producing an additional unit of a product, average cost shows the total cost of production per unit.

Just a small addition to this thought:

Think of the marginal cost as being at a point in time, whereas the average total cost is calculated over a period of time. As a result, marginal cost at any given point may be higher or lower than an average total cost.

Quick example:

ABC manufactures a product they call Widget A

Widget A sells for a price of $20

ABC sells 1,000 units of Widget A

Fixed costs for this production run are $5,000, regardless of # of units sold

Variable costs are $12 per unit

Gross Revenues $20,000

Fixed Cost Expense $ 5,000

Variable Cost Expense $12,000

Gross Profit $ 3,000

Breakeven # of units can be calculated as follows:

20x = 5000 + 12x. Solving for x gives 625 units to break even. At this point the Average Transaction Cost equals the selling price of $20 per unit. As each additional unit is produced the ATC will decrease since the only additional cost is the variable cost of $12 per unit. Therefore, in this very simple example, the MARGINAL COST of producing each unit OVER 625 would be the $12 variable cost expense. In the example above, at 1,000 units the Average Transaction Cost is $17 ($5 per unit for Fixed and $12 per unit for Variable), which is a decrease from the $20 ATC at break even.

Answer 2

The marginal product curve is 'n' shaped because of the law of diminishing returns. As you add more units of a variable factor, at first, the marginal product rises, (this is because the fixed factor is under-utilised, so adding more units of the variable factor will increase the output from each additional unit). But after a certain point, the marginal product begins to fall, as the fixed factor input becomes diluted amongst workers and so you get less from each additional unit of the variable factor.

For an example, re-read the above paragraph and replace the word variable factor with labour and fixed factor with capital.

The marginal cost curve is the inverse of the marginal product curve - hence it is shaped like a 'u' or a 'Nike tick'. This is because if your marginal product is high - then your marginal costs are low. For example, if a firm must pay electricity for the time it takes to produce a unit, if the firm can produce the unit quicker (i.e. has a high marginal product) then the cost of electricity will be lower. Hence the inverse relationship between marginal cost and marginal product.

Answer 3

We usually assume that the Average Cost curve is U shaped The MC curve will intercept the AC curves at its minimum point. When AC is decreasing, MC lies below AC - because when MC is below AC, producing an extra unit of output will pull down average cots When AC is increasing, MC lies above AC - because when MC is above AC, producing an extra unit of output will raise average costs Therefore MC will intercept the AC curve at its minimum point

Answer 4

In the short run (which is what this question is about), as output increases, the average total cost decreases where the marginal cost is below it.

First you have to realise that increasing and decreasing output will affect average fixed costs and average variable costs.

Consider the following (explanation to these specific points is at the bottom of the page):

• Average fixed costs (AFC) decrease as output increases.
  • A fall in average fixed costs leads to a fall in marginal costs.
  • Let's call the decrease in AFC, and therefore a decrease in marginal costs, "X"

• Average variable costs (AVC) increase as output increases.
  • It's the one most associated with marginal cost.
  • A rise in average variable costs leads to a rise in marginal costs.
  • Let's call the increase in AVC, and therefore an increase in marginal costs, "Y"

It is possible to deduce that:

• When X is greater than Y, the decrease is greater than the increase in marginal costs. Because it's going down more than it's going up, marginal cost is going to get pulled down and fall.
• When X is less than Y, the decrease is smaller than the increase in marginal costs. Because it's going up more than it's going down, marginal cost is going to get pulled up and rise.

You've just read about how marginal costs go up and down, according to the average variable & fixed costs. Now to pull in average total costs, as if it wasn't annoying enough.

The average total cost (ATC) of the firm is found by: Average fixed costs + average variable costs

Average total cost essentially changes depending on marginal costs (MC).

• If marginal cost is below average total cost, the average is going to get pulled down.
  • It's important to remember that MC can rise even if it's below the average... but eventually it will rise above it.
• If marginal cost is above average total cost, the average is going to get pulled up.
• Marginal cost always equals the average total cost when the average is at its lowest.
  • This is when the two curves cross over each other, and is linked to the law of diminishing marginal returns.

So, the change from a decreasing ATC to an increasing one is caused by a rising MC.

Because AVC is the thing that really pulls MC up significantly, leading to the change, it is the most important factor when considering these types of costs... because AFC eventually flatterns out and doesn't really make a difference as output is increased more and more.

Why does average fixed cost & average variable cost change?

• If output is increased, since fixed costs in the short run stay the same, average fixed costs will be lowered (average fixed costs = fixed cost divided by quantity of output). The cost is being spread out over the quantity.
• If output is increased, average variable costs necessarily increase, because variable costs are things like raw materials that you really need for production. If production output is at 0, then the average variable cost will be 0 too!

Answer 5

Marginal revenue is the change in total revenue with respect to the variable that's changing (usually quantity.)

Using calculus,

MR = d(TR)/dQ, where Q is quantity.